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Question

Explain the conditions of equilibrium of a firm based on marginal cost and marginal revenue. Use diagram.

Or

Explain the meaning of producer's equilibrium. Also explain the conditions of equilibrium of a firm on marginal cost and marginal revenue.

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Solution

A firm is in equilibrium, i.e. maximizes profits, when it produces that quantity of output at which:

(1) MC = MR and

(2) MC becomes greater than MR if more output is produced

In the graph the equilibrium is at E and the equilibrium output is OQ2 . At point A also MC =MR but this is not equilibrium because beyond A, MC is lower than MR. It is in the interest of the firm to produce more and add to profits. Therefore, only that output level at which MC= MR, and beyond which MC >MR, is the equilibrium.


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