A firm is in equilibrium when it has no tendency to change its level of output. It needs neither expansion nor contraction. It wants to earn maximum profits. In the words of A. W. Stonier and D.C. Hague, “A firm will be in equilibrium when it is earning maximum money profits.” ’ Equilibrium of the rm can be analysed in both short- run and long-run periods. A firm can earn the maximum profits in the short run or may incur the minimum loss. But in the long run, it can earn only normal profit.
Short run Equilibrium of the Firm :
The short run is a period of time in which the firm can vary its output by changing the variable factors of production in order to earn maximum profits or to incur minimum losses. The number of firms in the industry is fixed because neither the existing firms can leave nor new firms can enter it.
It’s Conditions: The firm is in equilibrium when it is earning maximum profits as the difference between its total revenue and total cost.
For this, it essential that it must satisfy two conditions:
(1) MC = MR, and
(2) the MC curve must cut the MR curve from below at the point of equality and then rise upwards. The price at which each firm sells its output is set by the market forces of demand and supply. Each firm will be able to sell as much as it chooses at that price. But due to competition, it will not be able to sell at all at a higher price than the market price. Thus the firm’s demand curve will be horizontal at that price so that P = AR = MR for the firm.
Marginal Revenue and Marginal Cost Approach :
The short-run equilibrium of the firm can be explained with the help of the marginal analysis as well as with total cost total revenue analysis. We first take the marginal analysis under identical cost conditions.
This analysis is based on the following assumptions:
(1) All firms in an industry use homogeneous factors of production.
(2) Their costs are equal. Therefore, all cost curves are uniform.
(3) They use homogeneous plants so that their SAC curves are equal.
(4) All firms are of equal efficiency.
(5) All firms sell their products at the same price determined by demand and supply of the industry so that the price of each firm is equal to AR = MR.
Determination of Equilibrium:
Given these assumptions, suppose that price OP in the competitive market for the product of all the firms in the industry is determined by the equality of demand curve D and the supply curve S at point E in Figure 1 (A) so that their average revenue curve (AR) coincides with the marginal revenue curve (MR).
