Equilibrium of the Firm – Marginal Revenue and Marginal Cost Approach.

 A firm will come into equilibrium when two conditions are fulfilled. (i) The MR is equal to MC; and (ii) Mc must cut MR from below. We shall look into the equilibrium of firm when; (a) AR and MR are horizontal to X-axis and (b) AR and MR have downward slope form left to right.

  • When AR and MR are horizontal. The figure given below the illustrate equilibrium of the firm.

When AR is constant MR becomes equal to it. MR intersects MC at R and R1. At both these points MC is equal to MR. Point R can not be a determinate equilibrium point since beyond this point, the MC is lower than MR and it is advantageous to the firm to produce more. By doing of, the firm can secure profits shown by the area RKR1. The determinate equilibrium point is in fact OQ for beyond that point MC and MR is not a sufficient condition of a firms equilibrium and that it is necessary that the MC curve cuts the MR curve from below, so that beyond the position of equality of MC and MR. MC is more than MR.

  • AR and MR having downward slope. The following figure shows that the firm has a downward sloping demand curve or average revenue curve. The corresponding MR curve is also down sloping from left to right. The MC curve is rising. At point R marginal cost curve cuts marginal revenue curve from below. This is equilibrium position of the firm. The equilibrium quantity is OQ and the equilibrium price is OP. The firm cannot produce beyond OQ because the additional cost of production will be higher than the additional revenue. At the same time, the firm will not like to produce less than OQ because its profits will not be maximized except at OQ. Therefore, the firm is in equilibrium when MC = MR

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