First order condition
Marginal revenue means the addition made to the total revenue by producing and selling an additional unit of output and marginal cost means the addition made to the total cost by producing an additional unit of output. Now a firm will go on expanding this level of output so long as an extra unit of output adds more to revenue than to cost, since it will be profitable to do so. The firm will not produce an additional unit of the product which adds more to cost than to revenue because to produce that unit will means losses. In other words, it will pay the firm to go on producing additional unit of output so long as the marginal revenue exceeds marginal cost. The firm will be increasing its total profits by increasing its output to the level at which marginal revenue just equals marginal cost. It will not be profitable for the firm to produce a unit of output of which marginal cost is greater than marginal revenue.
The firm will be making maximum profit by expanding output to the level where marginal revenue is equal to marginal cost. If it goes beyond the point of equality between marginal revenue and marginal cost, it will be incurring losses on the extra units of output and therefore will be reducing its total profit. Thus the firm will be in equilibrium position when it is producing the amount of output at which marginal revenue equals marginal cost.
In the figure, MC and MR, output intersects at E. This shows that the firm is in equilibrium where (MC=MR). When MC>MR, TP will fall. If the firm is producing more than equilibrium level MC>MR in this situation the firm should reduce its output till the equality between MC and MR.
When MC
Second order condition for equilibrium of the firm
The first order condition for the equilibrium output of the firm is that of its marginal revenue should be equal to marginal cost. There is a second order condition which must also be fulfilled if the firm is to be in a stable equilibrium position, thus equality between marginal revenue and marginal cost is a necessary but not a sufficient condition of firm’s equilibrium. The second order condition requires that for a firm to be in equilibrium marginal cost curve must cut marginal revenue curve from below at the point of equilibrium. If at the point of equality between MR and MC, the MC curve is cutting MR curve from above them beyond this equality point MC would be lower than MR and it will be profitable for the firm to expand output beyond this equality point. It is thus clear that the output at which marginal revenue is equal to marginal cost but marginal cost curve is cutting marginal revenue curve from above can’t be the position of stable equilibrium because the firm will have a tendency to increase its output further in spite of the equality between marginal revenue and marginal cost.
In the above fig, MR curve is a horizontal straight line and MC curve is U-shaped and is cutting MR curve at two points, F and E. the firm cant be in equilibrium at point F at which MC is equal to MR. this is because MC curve is cutting MR curve from above at point F corresponding to ON output with the result that beyond ON output MC is lower than MR and it is therefore profitable for the firm to expand output beyond ON. Actually, at ON output the firm is making losses equal to the area between MC curve and MR curve. It is thus clear that in spite of the fact that marginal revenue and marginal cost are equal at output ON, the firm is not in equilibrium since it is profitable for it to expand further.
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1 comments:
Nice explanation.
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