Just as consumers seek to maximize their satisfaction and utility by reaching consumer equilibrium, producers strive to reach a point that maximizes their profits, known as "producer equilibrium."
What is Producer's Equilibrium?
Producer's equilibrium is the point on the scale of production at which the level of production of any particular commodity yields the maximum profit for the producer of that commodity. At that point, the production cost of that commodity will be much less than the total revenue obtained through the sale of that commodity. It is the maximum possible profit that any producer can obtain at that equilibrium point.
In other words, producer equilibrium refers either to the level of profit maximisation or, otherwise, to the level of cost minimisation.
Cost minimisation also results in profit maximisation.
Definition of Producer Equilibrium in Economics
- Producer's equilibrium can be defined as a state of economic condition that leads to the achievement of that level of output, after which no further maximization of profit is possible.
- It is the stage where there is no further inclination towards expansion or contraction of the output.
- It is a point at which there is either maximum profitability and/or minimal loss.
Different Approaches in Studying Producer's Equilibrium
There are two approaches for reaching out to producer's equilibrium:
1) the TR - TC approach and
2) the MR = MC approach.
There can be Two Types of Markets for studying producer equilibrium
a) Perfect competition market where prices remain constant and
b) Imperfect competition market where prices are either rising or falling constantly.
We need to study the equilibrium under both these market conditions.
Now, let us study the producer's equilibrium under all these different conditions, one by one.
I) Total Revenue - Total Cost (TR - TC) Approach
Under the TR - TC approach, the producer tries to attain the equilibrium point by maximising his profits to the utmost possible level. So, this implies that the TR-TC approach should satisfy the following two conditions.
- The difference between Total Revenue and Total Cost has been maximised.
- Any further effort to increase output after that point will result in a fall in total profit.
Let me explain this approach under both Perfect Competition and Imperfect Competition.
i) The producer equilibrium under perfect competition (When prices remain constant)
When prices are constant in perfect competition, the producer goes on increasing his output or sales and is able to enjoy maximum profit till a certain point, after which he may not be able to produce more without adding extra machinery or extra expenses and capital.
The addition of capital and machinery may increase the product's costs and force him to raise the sale price or face a loss. Alternatively, he may not be able to sell more unless he lowers the price, which may also reduce profits.
So, he is forced to maintain the status quo at the equilibrium level.
Let us study the same point through the table below:
Price per unit Output (units) Total Revenue Total Cost Profit
6 1 6 5 1
6 2 12 10 2
6 4 24 19 5
6 6 36 28 8
6 7 42 34 8
6 8 48 41 7
From the illustration above, we can see that producer equilibrium has been achieved at the output level of 7 units, at which point you are enjoying a maximum profit of 8 dollars by producing 7 units. When you tried to increase the output by another unit, the profit decreased to 7 dollars.
The same thing can be illustrated in the form of a graph also. But I am not doing the graph.
ii) Now, watch producer equilibrium under imperfect competition (when prices are falling upon increased output )
There is no control over the prices, and each producer has his own price norms and sells products accordingly.
But, after a certain level of output, he is forced to lower the prices as his stocks are accumulating.
The example below illustrates this position.
Price per unit Output (units) Total Revenue Total Cost Profit
8 2 16 10 6
7 3 21 14 7
6 5 30 21 9
5 6 30 23 7
The producer equilibrium in the above example is attained at an output level of 5 units. He was making profits at production levels of 2, 3, and 5 units.
But after the output level of 5 units, an additional unit resulted in a fall in total profit.
II) Marginal Revenue = Marginal Cost Approach (MR = MC approach)
According to this approach, producer equilibrium is attained where the marginal revenue from an additional unit of output equals its marginal cost.
This approach should satisfy the following two conditions or assumptions:
1) MC = MR
2) Marginal cost becomes higher than Marginal Revenue if one more unit of output is produced after reaching the output level of MR = MC
Let us study this approach also under both the perfect and imperfect competition conditions of the market.
i) Producer equilibrium under perfect competition (when price is constant)
When price is constant, each unit of output is sold at the same price.
So, the average price (AR) of any particular unit is the same for every unit.
The marginal revenue (MR) will be the same, as the prices are constant for each unit.
So, you will enjoy producer equilibrium until there is a rise in MC or a fall in MR.
Let me illustrate this with a table as below:
Let us assume that the price is constant at Rs 6, but the cost of producing additional units differs. The MC figure shows the additional value per each additional unit.
Price (Rs.) No.of units TR TC MR MC Profit (TR-TC)
6 1 6 8 6 8 -2
6 2 12 15 6 7 -3
6 3 18 20 6 5 -2
6 4 24 24 6 4 0
6 5 30 28 6 4 2
6 6 36 34 6 6 2
6 7 42 41 6 7 1
From the above, we can see that the producer was initially incurring losses, and he increased his output to eliminate them and make profits.
When he produced 4 units, there were no losses.
At levels of 5 and 6 units of production, he was able to make profits of 2 points.
At 6 units of production, MR is equal to MC. When he tried to increase output by one more unit, the profit decreased again.
So, the producer's equilibrium output is 6 units in this case.
ii) Producer equilibrium under imperfect competition (when price falls with increase in output)
When there is no perfect competition among sellers, producers and sellers try to maximize their profits by engaging in unhealthy practices. They take advantage of monopolistic opportunities and charge very high prices to gain maximum profits.
This is workable up to a point. But when the produced quantity is much larger and identical alternative products enter the market, demand gets distributed among identical products, and each brand naturally loses demand in the long run.
The effect will be a fall in product prices. So, too much increase in production will result in a fall in prices. In such circumstances, the producer has to decide on his maximum level of production based on producer equilibrium. He will try to match Marginal Cost with Marginal Revenue in deciding his level of production.
Let us consider an example to arrive at this producer equilibrium under fluctuating market prices.
Qty. produced Price per unit Total Total MR MC Profit
Revenue Cost (TR-TC)
1 8 8 6 8 6 2
2 7 14 11 6 5 3
3 6 18 15 4 4 3
4 5 20 18 2 3 2
In the illustration above, MR and MC are equal at the production level of 3 units. Beyond that level, when production increases to 4 units, profit begins to decrease because MC is higher than MR at that point. (The profit dropped from 3 to 2.)
So, the producer's equilibrium level of output is 3 units in this case.
From the above study of producer equilibrium, we noticed two salient features:
1) Under perfect competition (where prices remain constant), Price = MR = MC, ie., the product price, marginal revenue, and marginal cost are equal to one another at the equilibrium point.
2) Under imperfect competition (where prices fall with every increase in supply or production), Price is always greater than MC or MR, as equilibrium is attained at a point where MC = MR, and marginal revenue will always be decreasing with additions of supply.
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