Equilibrium of the Firm in the Short Run (With Diagram)

MEANING OF A FIRM EQUILIBRIUM

The concept of a firm equilibrium occupies an important place in price theory. A firm is in equilibrium when it has no incentive either to expend or to contract it output. A firm would not like to change its level of output when its total profits are maximum. The rational entrepreneur will expand output if he thinks he can increase his total profit by doing so or vice versa. Therefore a firm is in equilibrium position when it is earning maximum profits. The equilibrium of the firm is usually discussed in two stages via Short Run and Long Run.

FIRM’S EQUILIBRIUM UNDER SHORT RUN

Short Run has been defined as a period of time long enough to allow the firm to adjust its output by increasing or decreasing the amount of variable of a factor of production i.e. Land and Labor, but during which factor of production cannot be altered. Why Average Revenue and Marginal Revenue is horizontal straight line. 
Under perfect competition, for an individual firm price is given. It works under the assumption that it can sell as much as it likes, at the prevailing price. Therefore the demand or average revenue curve facing the firm is perfectly elastic at the ruling price and addition made to the total revenue by marginal revenue is equal to the price (average revenue) of the commodity. Therefore the average revenue or demand curve and marginal revenue curve would coincide with each other for a firm under perfect competition.
FIRM’S EQUILIBRIUM UNDER SHORT RUN

In the above diagram, if price is prevailing in the market is OP, and then PL is both the average and marginal revenue curve. Profits are largest when MC=MR and Marginal Cost cut the Marginal Revenue curve from below rather than above. Point E in the diagram is a point where a firm can get maximum profit. Therefore (condition of firm’s equilibrium) under perfect competition.
  • MC = MR = PRICE 
• MC curve must cut MR curve from below. In short run there are three possibilities which tell about the absolute profit or loss position of the firm.

• When the firm makes Super Normal Profit
• When the firm makes only Normal Profit
• When the firm incurs Losses  

• When the firm makes Super Normal Profit

When the firm makes Super Normal Profit


In the above diagram the price prevailing in the market is OP, the marginal cost curve cut the marginal revenue curve at point E where the firm is in equilibrium position. In this equilibrium position the firm is making Super Normal Profit. There will be tendency for a new firm to enter into the industry to compete, so the existing firm will continue to earn super normal profit. 
Condition for Average Super Normal Profit = Average Revenue > Average Cost

Area Covered in Average Revenue = EQ 
Area Covered in Average Cost = EoQ 
Area for Super Normal Profit = EQ is greater than EoQ 
If, we deduct EQ – EoQ = Average Super Normal Profit (EEo)


• When the firm makes only Normal Profit

When the firm makes only Normal Profit


In the above diagram the price prevailing in the market is OP, the marginal cost curve cut the marginal revenue curve at point E where the firm is in equilibrium position. In this equilibrium position the firm is making Normal Profit. 
Condition for Average Normal Profit = Average Revenue = Average Cost 
Area Covered in Average Revenue = EQ 
Area Covered in Average Cost = EQ 
Area for Super Normal Profit = EQ is equal to EQ 
If, we deduct EQ – EQ = Average Normal Profit (EQ) 

• When the firm incurs Losses  
When the firm incurs Losses
In the above diagram the price prevailing in the market is OP, the marginal cost curve cut the marginal revenue curve at point E where the firm is in equilibrium position. In this equilibrium position the firm is making Super Normal Profit. There will be tendency for a new firm to enter the industry to compete, so the existing firm will continue to earn super normal profit. 
Condition for Loss = Average Revenue < Average Cost 
Area Covered in Average Revenue = EoQ 
Area Covered in Average Cost = EQ 
Area for Super Normal Profit = EQ is greater than EoQ 
If, we deduct EQ – EoQ = Average Loss (EEo).

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