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Producer’s Equilibrium
A producer is in equilibrium at that level of output at which his profits are
maximum. It is the profit maximization situation. He has no incentive to increase
or decrease this level of output.

CONDITIONS OF PRODUCER’S EQUILIBRIUM

There are two approaches to analyze profits:

1.TOTAL REVENUE & TOTAL COST APPROACH.

2. MARGINAL REVENUE & MARGINAL COST APPROACH.

TOTAL REVENUE & TOTAL COST APPROACH.

Profit is the difference between total revenue and total cost. Profit is maximum
when difference between TR and TC is maximum. Symbolically ,

π = TR – TC where, π=profit.
Conditions: Producer operating in perfect competition maximizes his profit when
,

Difference between Total Revenue and Total Cost is maximum.

Graphically , profit is maximum where the vertical distance between TR and TC is

maximum or both the curves have the same slope.

In diagram:

• On X-axis output produced and sold is shown.

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• On Y-axis TR and TC is shown.

• TR is the total revenue curve which starts from origin and slopes
upwards

• TC is the total cost curve .It starts from Y-axis and is inverse S-
shaped

• AB is the maximum profit , showing maximum vertical distance

between TR and TC

• OQ is the equilibrium level of output which the producer will

produce and sell to earn maximum profit. At this level of output
both TR and TC have same slope.

If he produces more or less than this level , his total profit declines.

• point C is the break - even point where TR=TC and profit

is zero

• D is the shut- down point

• shaded areas represent losses.

MARGINAL COST AND MARGINAL REVENUE APPROACH

It is more useful to analyze the equilibrium of the firm with the help of Marginal
Revenue and Marginal Cost approach.

The producer is operating in perfect competition.

CONDITION: The producer is maximizing his Profit when,

1) MR=MC

2) slope of MC >slope of MR
It means-

MC curve must cut MR curve from below and MC curve must be rising at the
point of equilibrium .

In diagram:
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• On X-axis ,level of output produced and sold is shown.

• On Y-axis ,MC and MR are shown.

• MR is marginal revenue curve , it is horizontal to X-axis due to

perfect competition , MR=AR=price

• MC is the marginal cost curve. It is U-shaped due to Law of Variable

Proportion

• E is the equilibrium point when both conditions are fulfilling , ie.

1)MR=MC or Price =MC

2)MC is cutting MR from below and then rising.

• OQ is the equilibrium level of output which the producer will produce

and sell to get maximum profit.

If , he produces more than OQ , he will incur losses.( MR < MC )

• At point F , MR=MC but MC is falling, therefore it cannot be the

equilibrium point. ( MR > MC )

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UNIT – 3 THEORY OF SUPPLY

SUPPLY : Supply is the quantity of a commodity which is offered for sale at
different prices during a particular period of time .There are three elements of
supply.

1. Quantity of a commodity. 2.Price. 3. Time.

MARKET SUPPLY : It is the total quantity of a commodity offered for sale by all
the firms/ sellers at different prices during a particular period of time.

THE LAW OF SUPPLY

“Other things remaining same , when price of commodity rises , it’s quantity
supplied increases and vice-versa.”

There is positive relationship between price and quantity supplied.

The law can be explained with the help of supply schedule and supply curve.

SUPPLY SCHEDULE

It is the tabular presentation of the law of supply .It shows different quantity of a
commodity supplied at different prices.

Price Quantit
y
supplie
d

1 10 Kg

2 20 Kg

3 30 Kg

4 40 Kg

5 50 Kg

In the schedule ,when price rises from Rs.1

to Rs.5 ,the quantity supplied increases from 10kg. to 50kg.It shows positive
relationship between price and quantity supplied.

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SUPPLY CURVE

It is the graphical presentation of law of supply.

In the fig:

• On X- Axis,Quantity supplied is shown.

• On Y-Axis, Price of the commodity is

shown.

• SS is the supply curve which slopes upwards

from left to right.

It shows positive relationship between quantity

supplied and price.

Other things remaining the same means, only price will change and all other
factors like price of related goods ,technology ,price of inputs ,govt’s policy etc.
remain the same.

SUPPLY FUNCTION / FACTORS DETERMINING THE SUPPLY

There are a number of factors on which the supply depends.

The supply function shows functional relationship between quantity supplied and
factors affecting it.

Sx = f ( Px , Pr , Tech , PF , Gp , GF -------------)
PRICE OF THE COMMODITY (Px ) : At higher prices , producer offers more
quantity of the commodity for sale and vice-versa. There is direct relationship
between price and quantity supplied.

PRICE OF RELATED GOODS (Pr ) : In case of substitute goods ,there will be

negative relationship between price of one good and demand for another good. A
fall in price substitute good will lead to increase in supply of the other good.

TECHNOLOGY (Tech ):Technological advancement leads to fall in cost of

production and increase in supply of that commodity.

Backward technology leads to increase in cost of production and decrease

in supply of that commodity.

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PRICE OF FACTORS OF PRODUCTION (PF) : An increase in price of inputs

increases the cost of production and leads to fall in supply of that commodity and
vice-versa.

GOVERNMENT POLICY( TAXATION & SUBSIDY ) Gp : An increase in excise

duty will cause increase in cost of production and decrease in supply of that
commodity and vice-versa.

Subsidy will also cause fall in cost of production and therefore , increase in supply.

GOAL OF THE FIRM (Gf) : In case of profit maximization policy ,supply of the
commodity is decreased by the firm at the same price.

In case of sales maximizing policy ,the firm will increase the supply at the same
price.

CHANGES IN QUANTITY SUPPLIED / EXPANSION &

CONTRACTION INSUPPLY
( MOVEMENT ALONG SAME SUPPLY CURVE )

Sx = (Px , Pr , Tech , Pf , Gp , Gf --------)

It refers to change in quantity supplied of a commodity due to change in it’s price

(other factors remaining same ).

Graphically, it is the upward & downward movement along the same supply
curve.

It has two aspects :

1.EXPANSION /EXTENTION OF SUPPLY: It refers to rise in quantity supplied due

to rise in price .

Graphically, it is the upward movement along the same supply curve. In the fig, it
is the movement from A to B on SS supply curve.

Fig.

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CONTRACTION OF SUPPLY: It refers to fall in quantity supplied due

to fall in price of the commodity.
Graphically, it is the downward movement along the same supply curve. In fig , it
is the movement from B to A on SS curve.

Fig.

CHANGE IN SUPPLY / INCREASE & DECREASE IN SUPPLY /

SHIFT IN SUPPLY CURVE.
Sx = ( Px , Pr , TECH ,PF ,-------------)

When quantity supplied changes due to change in other factors at the same price ,it
is called change in supply.

Graphically, it is rightward and leftward shift in supply curve.

It has two aspects:

INCREASE IN SUPPLY: It means increase in quantity supplied at the same price. It

is due to change in other factors .

• Improvement in technique of production.

• Fall in price of substitute goods.

• Fall in price of inputs leading to fall in cost of production.

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• Fall in Excise Duty or increase in subsidies leading to fall in cost of

production.

Graphically , increase in supply is shown by rightward shift in supply curve from

SS toS1 S1

In fig.Quantity supplied increased from OQ to OQ1 at the same price OP.

FIG.

DECREASE IN SUPPLY / LEFTWARD SHIFT:

It means less quantity is supplied at the same price. It is due to change in other
factors :

• Outdated techniques of production.

• Increase in price of substitutes

• Increase in price of inputs leading to increase in cost of production.

• Increase in Excise Duty leading to increase in cost of production.

Graphically, Decrease in supply is shown by leftward shift of supply curve from

SS to SoSo at the same price OP.

In fig. Quantity supplied decreases from OQ to OQo at the same price OP.

FIG.

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ELASTICITY OF SUPPLY
Elasticity of supply is a measure of percentage change in quantity supplied due
to percentage change in its price.

Measurement of elasticity of supply:

1.Percentage method : There may be three situations.

1.if percentage change in quantity supplied is more than percentage change in

price-

( elastic supply) ie. Es > 1

2. if percentage change in quantity supplied is less than percentage change in its

price –

( inelastic ) ie. Es < 1

3. if percentage change in quantity supplied is equal to percentage change in its

price-

(unit elasticity) ie. Es =1

2.Geometric method:
Three situations :

i) Any straight line supply curve passing through the origin has value of
elasticity equal to one. Es = 1

ii) If straight line supply curve goes through the X-axis,it is inelastic. Es < 1

iii) If a straight line supply curve goes through the Y-axis, it is elastic. Es >1

Fig
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