Question

Explain equilibrium of the producer (firm) using total revenue and total cost approach.

Answer 1

A producer reaches equilibrium when it earns maximum profit. Under the Total Revenue − Total Cost (TR-TC) approach, profit is calculated as:

Profit = Total Revenue (TR) − Total Cost (TC)

The firm is in equilibrium at the level of output where:

• The difference between TR and TC is the greatest.
• The slopes of TR and TC are equal at this point (i.e., MR = MC).
• Beyond this point, increasing output reduces profit.

Explanation of the Diagram:

From the diagram (Fig.), we can see that up to output level OL, the Total Cost (TC) is higher than Total Revenue (TR), meaning the firm is making losses.
At OL, TR becomes equal to TC, and the firm makes no profit or loss; this point is called the break-even point.

When output increases beyond OL, TR becomes greater than TC, and the firm starts earning profits, which continue to rise until output reaches ON.

However, after ON, TC once again exceeds TR, leading to losses.
So, the firm will operate only between OL and ON, where profit is possible.

Within this range:

• The gap between TR and TC first widens, meaning profits are increasing.
• Then the gap narrows, meaning profits begin to fall.

Therefore, the maximum profit occurs somewhere between OL and ON.