Equilibrium of a Firm
The word "equilibrium means a state of balance. When the object under the pressure of forces working in opposite direction has no tendency to move in either direction, the object is in equilibrium. Similarly a firm is said to be in equilibrium when it has no tendency to change its level of output, that is, when it has no tendency either to increase or to contract its level of output. The firm will produce the equilibrium level of output and will charge the price at which the equilibrium output can be sold in the market. Equilibrium of the firm has also to be achieved in respect of output it has to produce. So we can say the firm is in equilibrium, when given certain demand and cost conditions, it has struck upon the level of output at which it will stick on and will have no tendency to change it.
Equilibrium of the firm depends upon the objective it wants to achieve. However, the goal of profit maximization by the firm is still believed to be the most important and the theory of the firm has been extensively developed with maximization of profits as the objective of the firm. Therefore, in our analysis of equilibrium of the form, we will assume that it aims at maximizing its profits .The firm will therefore be in equilibrium when it is producing a level of output at which it is making maximum money profits. Now, profits are the difference between total revenue and total cost. So, in order to be in equilibrium, the firm will attempt to maximize the difference between total revenue and total cost.
It is to be noted that presently here, we are concerned with the analysis of equilibrium of firms in general terms. Here we shall derive general condition of equilibrium which are valid under all types of market. An old method of explaining the equilibrium of the firm is to draw the total revenue and total cost curves of the firm and locate the maximum profit point .But with the development of the approach of marginal analysis, equilibrium of the firm in modern micro-economics theory is explained with the aid of marginal revenue and marginal cost curves. The equilibrium of the firm can be explained in two ways-
- Total Revenue-Total Cost Approach
- Marginal Revenue-Marginal Cost Approach
Total Revenue and Total Cost Approach
A firm is in equilibrium when it is earning maximum profit. A firm will go on increasing its output if its profit is increasing. It will fix output at the level where it is making maximum money profits. Profit is the difference between Total Revenue and Total Cost i.e. (TR-TC). Thus, the firm will be in equilibrium at the level of output where the difference between TR and TC is greater. It can be shown with the help of the following figure:
Above figure presents what is called breakeven chart by businessmen. In this figure Total Revenue Curve TR and Total Cost Curve TC measured by OY-axis and output at OX-axis. TR starts from the origin, which means that when no output is produced, revenue is zero. TR goes on increasing as more output is produced. However, it will be noted that TC curve starts from a point F which states that even when there is no production, the firm has to ensure some cost i.e. OF. For instance, when the firm stops production in short-run, it has to bear fixed cost. Thus, the figure depicts short-run TR and TC. As a firm starts from zero output and increases its production of the good, in the very initial stage, TC is greater than TR and the firm is not making any profit at all. When it is producing OL level of output, TR is just equal to TC and the firm is therefore making neither profit nor losses i.e. the firm is only breakeven. Thus OL is called the breakeven point.
When the firm increases its output beyond OL, TR becomes larger than TC and profits began to assure to the firm. It will be seen from the figure that profit is increasing as the firm increases production to output
Profit can also be shown with the help of profit curve where, profit is maximum at point D and declines thereafter.
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