Producer’s Equilibrium :
A Firm or Producer:
A firm is defined as an economic entity which employs factors of production to produce commodities that it sells to other people.
OR
An individual or a unit or an organiser that produces goods and services is called a firm or a producer. The desire for profit motivates firms to produce goods and services.
A firm performs two kinds of functions in an economy:
1. A firm buys the factor services largely from the households as well as from various business entities and uses these to produce goods and services.
2. The firm transforms inputs into outputs. Various firms operating in an economy bring together different factors of production such as labour and capital, to produce goods and services. Firms are the basic units which take decisions about what goods and services to produce and in what quantities. Decisions with regard to prices and the amount of output of different commodities are taken by the firms.
Some firms are very small like grocery shops, vegetable shop, bakeries and restaurants.
Other firms are very large such as Reliance Industries Ltd.
Firms Equilibrium or Producer’s Equilibrium :
# Equilibrium :
Equilibrium is a state of rest. When equal amount of forces, working in opposite direction from a balance, so that there is no tendency to move in either direction, it is called equilibrium.
# Firm’s Equilibrium :
A firm is in equilibrium when, given the diamond and cost conditions, it produces that level of output at which its profit is maximised.
Producer’s equilibrium is also defined as a state where a producer is earning maximum possible profit by producing a particular level of output. It is referred to as equilibrium because a producer has no incentive to move away from this point, as such deviation will reduce his or her profit.
A firm is in equilibrium when it maximises its profits. It is in equilibrium in the sense that if the firm selects that level of output at which the profit is maximised, it would like to produce that level of output only. There is no reason and incentive for the firm to change the level of output. There is no scope for either increasing the profit or reducing its loss by changing the quality of the output.
# Profit :
Profits are defined as the difference between the revenue that the firm earns from selling its output and the cost of producing that output, i.e.,
Ï€ = TR – TC
Where π = total profit
TR = Total Revenue
TC = Total Costs
To maximise the profit, the difference between TR and TC should also be maximum.
Therefore, a profit maximising firm tends to produce that output and charge that price which maximises the difference between TR and TC.
So per unit profit depends upon revenue per unit and costs per unit. A profit maximising firm will produce that output which maximises the difference between AR (average revenue) and AC (average cost).
# Normal Profit:
Normal profits are defined as “that amount of profit that are high enough so that firms in the industry are induced to remain in the industry, yet low enough so that new firms do not want to enter the industry.”
Normal profits are pure returns on capital and risk premium needed to compensate the entrepreneur for the risks involved in production.
Normal profits are considered a part of cost of production and are included in the cost.
# Pure Profit or Economic Profit or Super normal profit:
Excess of revenue over costs (including normal profits) is what we call pure profits or economic profits in economics.
When revenue equals costs, then the firm earns only normal profits, but if revenue is in excess of costs, then the firm earns ‘pure’ or ‘economic’ or ‘super – normal’ profit.
Positive pure profit would attract the resources owners into the industry to earn high profits.
Losses (or negative profits) would induce the resource owners to move resources elsewhere.
Determination of Producer’s Equilibrium or Firm Equilibrium:
Since a firm operates to maximise its profits, it is said to be in equilibrium at that level of output at which its profits are maximum. Profit – maximisation rules are, therefore, also the rules of equilibrium of a firm.
There are two ways of explaining how a firm reaches its equilibrium level by maximising profits –
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