Definitions [1]
Definitions: Equilibrium of Firm
- "A firm is a unit engaged in the production for sale at a profit and with the objective of maximising profit." - Prof. Watson
- ''Where profits are maximised, we say the firm is in equilibrium". - Prof. R.A. Bilas
Key Points
Key Points: Firm : An Economic Entity
- A firm is an economic unit/business that organises factors of production to produce goods and services and sells them to earn profit.
- Firms buy factor services (land, labour, capital, entrepreneur) from households and other firms.
- Firms transform inputs into outputs and decide what to produce, how much to produce, and at what price to sell.
- Firms can be small (shops, small businesses) or large (big companies).
- Common types of firms are sole proprietorships, partnerships, and companies/corporations.
Key Points: Firm’s Equilibrium
- Firm’s equilibrium: A firm is in equilibrium when it produces the level of output that gives maximum profit, with no tendency to change output.
- Conditions: Profit is maximum, MC = MR, and MC cuts MR from below.
- Approaches: TR – TC approach and MR – MC approach.
- Equilibrium price: The price at which quantity demanded equals quantity supplied, assuming downward-sloping demand, upward-sloping supply, and flexible prices.
Key Points: Profit Maximisation Objective
- Firms are assumed to mainly aim at profit maximisation.
- Economic profit = TR − TC.
- Normal profit is the minimum reward needed to keep a firm in the industry and is part of the cost.
- Pure (economic/supernormal) profit is the extra over and above all costs, including normal profit.
- Under the TR–TC approach, profit is maximum where the TR–TC gap is the largest.
Key Points: Producer’s (Firm’s) Equilibrium: Total Revenue and Total Cost Approach
- Producer’s equilibrium (TR–TC approach) is the level of output where profit (TR − TC) is maximum and any change in output reduces profit.
- Under perfect competition, TR is a straight‑line curve from the origin because price is constant.
- The short‑run TC curve starts above the origin due to fixed costs and is S‑shaped.
- Break‑even outputs occur where TR = TC (no profit, no loss) – points B (OL) and D (ON).
- The profit‑making range of output lies between OL and ON, where TR > TC.
- Equilibrium output OM is where the vertical distance between TR and TC is greatest and, equivalently, where MR = MC.
- The TP curve is maximum at equilibrium output and is negative outside the profitable range.
- The TR–TC method is intuitive but does not directly show price per unit and makes it difficult to eyeball the exact profit‑maximising output.
Key Points: Producer's (Firm's) Equilibrium: Marginal Revenue and Marginal Cost Approach
- Producer’s equilibrium is the situation where a producer maximises profit or minimises loss and has no tendency to change output.
- Rule 1 (Shutdown rule): In the short run, produce only if P or AR ≥ AVC; if P < AVC, shut down.
- Rule 2 (First-order condition): Profit is maximised when MR = MC.
- Rule 3 (Second-order condition): At equilibrium, MC is rising and cuts MR from below, so MC < MR just before equilibrium and MC > MR just after equilibrium.
- Both MR = MC and MC cutting MR from below are necessary and sufficient for producer’s equilibrium under the MR–MC approach.
