Equilibrium of the Firm and Industry

 

SHORT RUN EQUILIBRIUM OF THE FIRM

The firm is in equilibrium at the point of intersection of the marginal cost and

marginal revenue curves. The first condition for the equilibrium of the firm is that

marginal cost should be equal to marginal revenue. The second condition for equilibrium

requires that marginal cost curve should cut the marginal revenue curve from below.

SHORT RUN EQUILIBRIUM OF THE FIRM ngp bcca 1st year

The firm is in equilibrium only at ‘e’ because only at ‘e’ both the conditions are satisfied. At ‘e ‘ the firm is not in equilibrium as the second condition is not fulfilled.

The fact that the firm is in equilibrium in the short run does not mean that it makes excess profits. Whether the firm makes excess profits or losses depends on the level of average total cost at the short run equilibrium.

In figure . (A), the SATC is below the price at equilibrium; the firm earns excess profits.

In figure . (B), the SATC is above the price; the firm makes a loss.

In the short run a firm generally keeps on producing even when it is incurring losses. This is so because by producing and earning some revenue, the firm is able to cover a part of its fixed costs. So long as the firm covers up its variable cost plus at least a part of annual fixed cost, it is advisable for the firm to continue production. It is only when it is unable to cover any portion of its fixed cost, it should stop producing. Such a situation is known as shut down point. The shut down point of the firm is denoted by W.

If price falls below P the firm does not cover its variable costs and is better off if it closes down.

SHORT RUN EQUILIBRIUM OF THE FIRM 1 ngp bcca 1st year

SHORT RUN EQUILIBRIUM OF THE FIRM B ngp bcca 1st year SHORT RUN EQUILIBRIUM OF THE FIRM C ngp bcca 1st year

 

Long-run equilibrium of the firm

In the long run firms are in equilibrium when they have adjusted their plant so as to produce at the minimum point of their long run AC curve, which is tangent to the demand curve. In the long run the firms will be earning just normal profits, which are included in the LAC. The long run equilibrium position of the firm is shown in figure

Long run equilibrium of the firm ngp bcca 1st year

At the price of OP, the firm is making excess profits. Therefore, it will have an incentive to build new capacity and hence it will move along its LAC. At the same time, attracted by excess profits new firms will be entering the industry. As the quantity supplied increases, the price will fall to Pi at which the firm and the industry are in longrun equilibrium. The condition for the long-run equilibrium of the firm is that the marginal cost tie equal to the price and to the long run-average cost.

LMC = LAC = P

The firm adjusts its plant size so as to produce that level of output I which the LAC is the minimum. At equilibrium the short run marginal is equal to the long run marginal cost and the short run average cost is equal to the long run average cost. Thus, in equilibrium in the long

SMC = LMC = LAC = SAC = P = MR

This implies that at the minimum point of the LAC the plant worked at its optimal capacity, so that the minimal of the LAC and SAC coincide.

 

Short- runs Equilibrium of the industry.

Given the market demand and market supply, the industry is in equilibrium at the price at which the quantity demanded is equal to the quantity supplied.

Short run industry equilibrium A ngp bcca 1st year

(Short run industry equilibrium)

short run equilibrium profits ngp bcca 1st year

(Short run Equilibrium Profits)

 

The industry is in equilibrium at price P at which the quantity demanded and supplied is OQ. However this will be a short-run equilibrium as some firms are earning abnormal profits and some incur losses as shown in figures 5. (B) and 5. (C) respectively.

In the long run, firms that make losses will close down. Those firms which make excess profits will expand and also attract new firms into the industry. Entry, exit and readjustment will lead to long run equilibrium in which firms will be earning normal profits and there will be no entry or exit from the industry.

Long-run Equilibrium of the Industry

The industry is in long run equilibrium when price is reach which all firms are in equilibrium producing at the minimum point oft LAC curve and making just normal profits. Under these conditions there is no further entry or exit of firms in the industry.

The long run equilibrium is shown in the figure

Long run industry equilibrium ngp bcca 1st yearLong run industry equilibrium B ngp bcca 1st year

At the market price P the firms produce at their minimum cost, earning just normal profits. The firm is in equilibrium because at the level of output x

LMC = SMC = P = MR

This equality ensures that the firm maximises its profit. At the price P the industry is in equilibrium because profits are normal and all costs are covered so that there is no incentive for entry or exit.

 

 

 

 

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