Producer’s Equilibrium refers to a situation of
‘profit maximization’.
A producer strikes his equilibrium at that level of
output where profit is maximized.
Any other output will yield lower profit.
Profit is calculated as the difference between TR
(Total revenue) and TC (Total cost)
Profit = TR – TC
Profit maximization rules are also the rules of
equilibrium of a firm.
These rules of a firm are common to all the firms operating
under different market structure.
There are two ways of explaining how a firm reaches
its equilibrium level of maximizing profits:
1) Total revenue and Total cost approach
Total revenue and Total cost approach
Profit is maximum when TR – TC is maximum. Hence, a
firm will maximize its profits at that level of output where the difference
between total revenue and total cost is the largest.
As explained in the graph below:
 |
| total revenue |
1) We have taken the case of perfect competition to
show firm’s equilibrium.
However, the same rules apply in case of imperfect
competition as well.
2) TR curve is a positively sloped rising from zero,
as output is increased, TR goes on increasing at a constant rate.
3) TC curve starts from point A on the Y axis (Total
fixed cost corresponding to zero level of output). It is positively sloping,
indicating that total cost varies directly with output.
It is concave downwards initially and concave
upwards subsequently, indicating that the total cost increases first at a
decreasing rate and then at an increasing rate.
4)Up to OL level of output, TC is greater than TR
(TC < TR), the firm is incurring losses to the extent of TC – TR.
5) At OL level of output, TR is equal to TC and the
firm is therefore making neither profits nor losses. It’s the situation of
break- even point.
TR = TC
Or, TR / Q = TC / Q
P = AC
A firm is just covering all its costs. The firm is
just making normal profits.
6) Beyond, OL, total revenue becomes larger than TC
and the firm begins to earn profits till its output reaches ON.
7) Beyond, ON, however TC becomes more than TR, and
the firm starts incurring losses again.
8) So firms profitable range of output lies between
OL and ON.
The distance between TR and TC increases first and then decreases,
meaning that profit first increases with increase in output, but beyond a
certain level of output it begins to decrease.
So maximum profit lies in
between OL and ON level of output.
9) Since the vertical distance between TR curve and
TC curve is widening.
At OM level of output, the distance between TR curve and
TC curve is the greatest and therefore profits will be maximum.
The total profits earned at OM level of output are
equal to CE. Thus, OM is the profit maximizing level of output.
The firm will not produce any output beyond OM since
the total profit will be decreasing as indicated by narrowing down of gap
between TR and TC curves.
10) Profit maximizing level of output can also be
identified by drawing Total profit curve showing the difference between TR and
TC at various level of output.
11) TP curve is total profit curve indicates the
vertical distance between TC and TR curves at various level of output.
TP curve first rises and then fall.Upto OL level of
output, the firm is making negative profits (losses) and so TP curve lies below
the X axis.
Beyond ON level of output also firm will earn loss.
At L level of output, profits are equal to zero.
It can be seen that profits reaches its maximum
level when output is OM. beyond OM level of output TP curve is negatively
sloped (fall in profit).
So at OM level of output the firm will be making
maximum profits.
OM is equilibrium level of output.
The profits earned at OM level of output are equal
to CE or GM.
TR and TC method of finding out the profit maximizing
level of output is quite reasonable and is often employed by businessman.
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