producer's equilibrium

meaning of producer.

producer is a person who produces goods and services for sale and his objective is profit maximization.

 Q2  define producer's equilibrium

Ans. the word equilibrium in economics has been taken from physics where it means, state of rest. but in economics it is used in different sense. so, producer's equilibrium is a situation where producer is in best possible situation. for eg. : if a producer gets maximum profits than he will in equilibrium where as in the situation of losses he gets minimum losses then producer is said to be in equilibrium and here he has no tendency to move away from the equilibrium situation.

Q3. what are various approaches to determine producer's equilibrium.

Ans. there are two approaches to determine producer's equilibrium:

i) TR and TC approach

ii) MR and MC approach

Q4 explain the producer's equilibrium with the help of MR and MC approach?

                              or

what is the general profit maximization condition of a firm?

                             or

show that a perfectly competitive firm maximizes its profit only when price = MC?

i) when MR is in straight line or P.E. under perfect competition :-

A producer is said to be in equilibrium when given level of output gives him maximum profit and he has no intention to change the level of output . with a view to maximise his profits, a produce upto that quantity at which following two conditions are fulfilled.

MC = MR  MC cuts MR from below.

 output                              MR                                 MC

    1                                     10                                   8

    2                                     10                                   7

    3                                     10                                   6

    4                                     10                                   8

    5                                     10                                  10

    6                                     10                                  13

the table is drawn on the assumption that price (AR) is constant so MR is constant (10)  we are assuming a situation of perfect competition. the table shows that two conditions are satisfied only when 5 units are produce :-

i) MR = MC

ii) MC, is cutting  MR from Below. (MC is rising )

the producer's equilibrium can be explained with the help of table and diagram.

we consider equilibrium of a producer who is working under conditions of perfect competition and takes the price of the product as given and constant for him.

 

 

 condition - I MC = MR

if the producer produces OM units, he can increase profits of the firm = T as MR = MC MC cuts MR from its below thus he want to increase production to OS, so as it earn maximum profits.

if on the other hand, the producer produces 400 units, then he suffers losses = after point T as  MC >MR, so the producer will prefer to produce till 350 units, where MC = MR, MR is rising and profit maximum.

condition-2 MC is rising

in the diagram MC curve cuts MR curve at point K and T. at point K , firm produces OM units of output, as the firm increase its output from OR units of output, as the firm increases its output from OR to OQ initially its MC will go to falling but MC is less than MR it means productions from OR to OQ will add to the profits of the firm.

this point K cannot be the point of equilibrium of the firms thus point E represent producer's equilibrium as at this point MC = MR and MC is rising.

Q5 explain producer's equilibrium with MC and MR method under imperfect competition?

 Ans- ii) when MR curve is downward sloping 

according to this approach a producer will be in equilibrium when following two conditions are satisfied.

i) MC = MR

ii) MC cuts MR from below

 

 

i) MC = MR 

MC = MR and MC is cutting MR from below, so here a producer will be in equilibrium.

ii) MR > MC

MR > MC, so here a firm will get profits. therefore a producer will increase output.

Q6 explain the determination of short run equilibrium of the firm under perfect competition?

Ans- producer's equilibrium  - short period and long period analysis

short period :-

it is a time period in which new firms cannot join the industry and existing firm cannot leave the industry.

in short period a firm or producer  will be in  equilibrium when following two conditions are satisfied 

i) MC = MR 

ii) MC, uts MR from below

in short period firm may have to face following three situations.

1. super normal profits or abnormal profits or extra normal profits :-

a firm will get super normal profits when price becomes greater than AC . or when TR >TC.

2.  normal profits or zero abnormal profits:-

a firm will get normal profits when price becomes equal to AC. TR = TC.

 

 

 

3.abnormal losses or extra normal losses:-

a firm will get losses when AC becomes greater than price. TR <TC.

 AR < AC  

 

Q8- what is shut down point ?

Ans- shut down point

it is the point where price becomes equal to AVC

price = AVC , so it is called shut down point.

gross profits = TR - TVC

net profits = TR - TC

Q9- only a rising segment of MC curve starting from the shut down point is considered as a short period supply curve of a firm. explain/

Ans- a competitive firm strikes its equilibrium, when at a given price, MR = MC and MC is rising. during the short period a firm will undertake production only if AR or P > AVC i.e. a short period supply curve of the firm starts from its shut down point, where P = AVC starting run supply curve would be the same as its MC curve which shows the price + quantity relationship.

In the diagram, the firm is in equilibrium where MR = MC and MC is rising.

P = AVC ( shut down point ) which is the starting point of firm's supply curve producing OQ quantity. when price increases the firm strikes equilibrium , and the firm produces OQ1 quantity. thus during the short period, rising segment of MC curve ( starting from the shut down point ) is the same as the firm's supply curve as it shows positive relationship between price and quantity supplied.

Q11. the break even point and shut down points are different how?

Ans. break even point occurs when the firm's total revenue is equal to the total cost i.e. no profit no lose situation.

             TR  =  TC                  or                AR  =  AC

shut down point is the point at which the market price of the product is equal to the AVC. fixed costs are not recovered at this point. the firm continuous production till this point as at least the variable costs is being recovered.

 TR  =  TVC     or     AR  =   AVC

\

 

 

 

 

 

 

 

 

concepts of revenue

meaning of revenue or sale proceed

by selling the commodity what ever money is received by the firm is called revenue.

suppose you are running a factory producing chocolates. you produce 1000 chocolates daily. by selling these chocolates you get RS 2,000. in economics , this amount of rs 2,000 is called revenue. thus, by selling a commodity whatever money a firm receives is called revenue.

                             or

revenue is the money received from sale of commodity.

difference between revenue and profits?

revenue and profits are different concepts

the concept of revenue is different from the concept of profit .

the following equations shows the difference:-

profit = revenue - cost

revenue = costs + profit

                                 concepts of revenue

i) TR ( total revenue)

ii)AR (average revenue)

iii)MR (marginal revenue)

i) total revenue (TR)  :- 

a revenue that a firms get by selling a given amount of output that is called total revenue.

TR = P*Q

TR = TOTAL REVENUE

P = PRICE PER UNIT

Q = QUANTITY SOLD

                or

TR =SUMMATION OF MR

TR = TOTAL REVENUE

MR = MARGINAL REVENUE

marginal revenue  ( MR)

it is change in total revenue as a result of selling an additional unit of output is known as marginal revenue. however it can be positive, zero nd negative.

MRn =TRn - TRn-1

MRn = marginal revenue of n units

TRn = total revenue of n units

TRn-1 = total revenue of n-1 units

                          or

 example

     P                       Q                      TR = P*Q                         MR

     5                       1                              5                                   5

     4                       2                              8                                   3

     3                       3                              9                                   1

     2                       4                              8                                  -1

     1                       5                              5                                  -3

MR2 =TR2 - TR1

         = 8  - 5

        =  3

average rvenue

it is the revenue per unit of output. it is obtained by dividing T. R with the quantity sold . AR is equal to price.                          

AR = Average revenue

TR = Quantity sold

             Q                          TR                             AR = TR/Q

             1                           10                                  10

             2                           20                                  10

             3                          30                                   10

             4                          40                                   10

Q4 show that AR = price ?

Ans. we know that

AR = TR/Q

we also known that TR = P ( where P = quantity or output sold)

relating the two equations we write that;

AR = P*Q/Q =  P

thus it is proved that AR = price 

Q5 Firm's demand curve or price line is the same as AR curve ?

ans. firm's demand curve or price line is the same as firm's AR curve, because AR means price\, and demand curve ( or Ar curve ) shows the relationship between  price and quantity demanded of firm's output.

Q^ what is relationship between TR, AR and MR under perfect competition ?

Ans. perfect competition is a market in which there are large number of buyers and sellers where as in this market product produce is homogonous and there is free entry and exit of firms .

in such a market price of commodity is determined by industry and firm followed that price A firm can sell any amount of commodity at this price.

    price            Q            TR = P*Q                MR                 AR = TR/Q

      10               1                  10                        10                        10

      10               2                  20                        10                        10

      10               3                  30                        10                        10

      10               4                  40                        10                        10

      10               5                  50                        10                        10

 

 

 

 !. it is clear from diagram MR is constant so TR is increasing at constant rate therefore TR is in a straight line moving upward.

2. AR and MR are equal to each other and it is shown by horizontal straight line where as AR = MR because industry is a pric maker and firm is price taker.

Q7 prove that area under AR & MR curve is equal to Tr in case of perfect competition ?

Ans. in case of perfect competition AR is constant therefore AR = MR. AR curve is horizontal line which represents the value of different level of output at uniform prove.

 

 

in the diagram, price ( equal to OP) is constant and output is equal to OQ.

TR = P*Q

      =  OP*OQ

     Area = OPRQ

Q8. what is relationship between TR,AR and MR?

Ans. the relationship between TR,AR and MR can be explained with the help of diagram.

 p           Q             TR              MR               AR

 10          1              10                10                10

  9           2              18                8                  9

  8           3              24                6                  8

  7           4              28                4                  7

  6           5              30                2                  6

  5           6              30                0                  5

  4           7              28               -2                  4

  3           8              24               -4                  3

  2           9              18               -6                  2

  1           10            10               -8                  1

 

 

 1. when MR is positive then TR is increasing as in the diagram upto point K, MR is positive. so, TR is increasing upto point E1.

 2. when MR is zero then TR is maximum as in the diagram at point K, MR is 0 and TR is maximum at point K'

 3. when MR is negative then, TR is falling as after point k, MR is negative and TR is falling. after point K'.

4. both AR and MR are decreasing but MR is falling at faster rate. so, MR is below than the AR.

 5. MR can be negative but TR and MR cannot be.

 6. both TR ad MR can be calculated from TR.

(a) MR = TRn - TRn-1

(b)AR = TR/Q

Q9 can MR be zero or negative ?

Ans. Yes, MR can be zero or negative. it is clear from the following illustrations;

Average revenue                output (units)            total revenue        marginal 

  price (Rs.)                                                               (Rs.)              revenue (Rs.)

      100                                    1                              100                      100

       80                                     2                              160                      60

       40                                     3                              160                      0

       30                                     4                              150                    -10

1. MR can be zero or even negative, but only when price is declining as under monopoly or monopolistic competition.

2. TR stops increasing when MR = 0 so that TR is maximum when MR = 0.

3. TR starts declining, less and less added to TR is every additional unit is sold. accordingly, TR increases only at the diminishing rate.

Q10 what is firm's price line/ what is its shape?

Ans. firm's  price line is the same as firm's AR curve. under perfect competition, firm's price line is a horizontal straight line. both AR and MR tend to coincide (AR=MR). under monopoly or monopolistic competition, firm's price line slopes downward. when AR sloped downward, MR also slopes downward, MR<AR.

 

 

 

 

 

 

 

 

 

 

 

 

 

                      

price elasticity of demand

 introduction of elasticity of demand

law of demand tells us that with the increase in price demand falls and with the fall in price demand increases. it does not tell about how much is the change in the demand due to change in price. elasticity of demand tells us about how much is the change in demand due to change in price, income and price of related goods.

meaning of elasticity

it means responsiveness of a dependent variable to change in independent variable.

                                or

it refers to the % change in qty. demanded and % change in own price of the commodity.

meaning of elasticity of demand

it is the demand which is affected by 3 factors.

i) price :- when demand changes due to change in the price of the commodity is called price elasticity of demand.

ii) income :- when demand changes due to change in income of the consumer i.e. called income elasticity of demand.

iii) related goods :- when there is change in demand due to change in price of related goods that is called cross elasticity of demand.

price elasticity of demand :-

the ratio of % change in demand  due to % change in price i.e. called price elasticity of demand 

 

 

degrees/types/kinds/ of price elasticity of demand 

there as 5 degrees of price elasticity of demand.

i) perfectly inelastic demand or zero elasticity of demand :-

when there is no change in demand due to change in price of commodity i.e. called perfectly, inelastic demand for e.g. salt, life, saving, drugs.

               price                                demand

                 10                                       10

                 11                                       10

                 12                                       10

                 13                                       10

                 14                                       10

                 15                                       10

 

 

it is clear from the diagram that demand curve is parallel to or vertical line to 'y' axis i.e. there is no change in demand due to change in price. so here ed is equal to zero. it is known as completely or totally inelastic demand. 

ii) less elastic demand or inelastic demand or less than unitary elastic demand :-

when % change in price is greater than % change in demand than elasticity of demand is less than unitary elastic demand ex. food, fuel etc.

              price                                demand

                  10                                     10

                   5                                      11

it is clear from the table that price falls by 5 Rs demand increases by 1 unit. this ed is said to be less than one.

 

 

 

 

it is clear from the diagram % change in price PP1 is > than % change in demand QQ1 i.e. why elasticity of demand is less than unitary elastic demand. the shape of demand curve is steeper.

iii) unitary elastic demand

when % change in price is equal to % change in demand than elasticity of demand is unitary elastic demand for e.g. clothes, normal goods.

            price                           demand

               10                                 10

                 9                                 11

it is clear from the table that price falls by 1 Rs and demand increases by 1 unit. the ed is said to be unitary elastic.

 

 

 

 

  it is clear from the diagram that % change in price PP1 is equal to % change in demand QQ1 so elasticity f demand is unitary. in this case area covered by each rectangle is equal so it takes the shape of rectangular hyperbola.

iv) greater than unitary elastic demand or elastic demand ;-

when % change in demand is greater than % change in price than elasticity is greater than unitary elastic demand. for example luxuries ( costly cars, costly carpets).

                      price                              demand

                         10                                    10

                         9                                      15

it is clear from the table price falls by 1 Rs and demand increases by 5 units. so ed said to be more elastic.

 

 

  it is clear from the diagram that % change in demand QQ1 is greater than % change in price PP1 so elasticity of demand is greater than unitary elastic demand. the shape of demand curve is flatter.

v) perfectly elastic demand or infinite elasticity of demand :-

when demand is infinite at the existing price than elasticity of demand is perfectly elastic in real world we never come across such type of elasticity of demand.

              price                         demand

                 10                              10

                 10                              11

                 10                              12

                 10                              13

                 10                              14

 

 here elasticity of demand becomes infinite and demand curve is 11 to 'x' axis. this type is an imaginary elasticity of demand so it does not exits in real world.

 

 

 Q- when two demand curves intersect each other which is having greater elasticity of demand?

Ans - if 2 demand curves intersect each other than  flatter  demand curve is having greater elasticity of demand.

 

 

  it is clear from the diagram that d1d1 and d2d2 are intersecting each other at point 'a' at this point price is op and qty. demanded for both the demand curve is Q2. if price falls from OB to OA the change in price is same for both the demand curves but change in Qty. demanded is different. on DD demand has increased from OQ2 to OQ1 where as for demand curve D1D1 demand has increased for OQ2 to OQ1. it is clear that % change in demand for flatter demand curve is more so elasticity of demand for flatter demand curve is more.

methods to measure PED

the following are the methods to measure price elasticity of demand 

1. % method or proportionate method

2. total expenditure method or total outlay method

3. point method or graphic method

1) proportionate method or percentage method

this method was given by Dr . marshall.

according to this method elasticity of demand is the ratio of % change in demand to % change in price.

 

 

 

 

  price                                  demand

  P  1                                    5 Q

 P1  5                                   4   Q1

 

total expenditure or total outlay method 

this method is given by Dr. Marshall. it works out relationship between PED and TE. this method measured PED by finding out how much and in what direction the total expenditure changed in price of the good.

according to this method total expenditure can be calculated by multiplying price per unit with qty. sold.  

T.E. = P * Q

P = price per unit       Q = quantity sold

according to this method there are 3 degrees of price elasticity of demand.

i) less than unitary elastic demand 

ii) unitary elastic demand 

iii) greater than unitary elastic demand 

i) less than unitary elastic demand

when there is positive relation between price and T.E. that is with the increase in price total expenditure increase and with the decrease in price T.E. decrease.

P increases T.E  increases

P decreases T.E. decreases     E < 1

ii) unitary elastic demand  :-

when there is no change in T.E. due to change in price is called unitary elastic demand.

price increases  or decreases T.E. same E = 1 

iii) greater than unitary elastic demand 

when there is inverse relationship between price and T.E. that is called greater than unitary elastic demand.

price increases T.E. decreases

price decreases T.E. increases  E > 1 

    P               Q                T.E.                        change in P                         PED

                                                                            & TE

    10             1                   10                              

    9               2                   18                         Price increases T.E.          greater 

    8               3                   24                      increases E > 1                than one 

    7               4                   28         

    6               5                   30                   price increases T.E.              unit

    5               6                   30                 same E = 1 

    4               7                   28                 price increases T.E.                 less than 

    3               8                   24                   decreases E < 1                        one

note :- the relationship between P & TE based on inverse relationship between P & Q .

 

 

 1. it is clear from the diagram when price falls from OP to OP1 total expenditure increases from PT to P1T1 so here elasticity of demand is greater than one.

2. when price falls from OP1 to OP2 T.E. remains the same i.e. P1T1 = P2T2 so here E = 1

3. when price falls from OP2 to OP3 T.E. falls from P2T2 to P3T3 so here elasticity of demand is E<1

point method / graphic method / geometric method

it was given by Dr. Marshall. this method is used to measure price elasticity of demand on the different points of demand curve. this method measures elasticity graphically. this method is called graphic method. According to this method following formula is used 

 

 

 

 

i) elasticity of demand at the mid point of demand curve or PED = 1 :-

at the mid point of demand curve lower portion is equal to upper portion. so here elasticity of demand is unitary elastic demand.

ED at Pt A = AL

                      AP

AL = AP 

ED = 1

ii) elasticity of demand below the mid point of demand curve PED<1 :-

in this situation lower portion is lesser than upper portion so here elasticity will be less than unitary elastic.

  Ed at Pt B = BL

                       BP

BL<BP

ED < 1

iii) elasticity of demand above the mid point of demand curve or PED>1 :-

in this situation upper portion is less than lower portion so here elasticity of demand will be more than unitary elastic.

  ED at Pt C = CL

                         CP

CP<CL

ED > 1

iv) elasticity of demand when demand curve touches 'x' axis or PED = 0 :-

in this situation elasticity of demand will be equal to zero.

Ed at Pt L = O

                    PL   = 0 

v) elasticity when demand curve touches Y axis or PED = infinity :-

in this situation elasticity of demand will be infinite.

  Ed at Pt P  = PL

                         O   = infinity

Q- the demand curve of a commodity is a straight line sloping downward as in the diagram. write true or false against the following statements :-

i) elasticity of demand is low corresponding to lower level of price of the commodity.

ii) elasticity of demand = 0, when price = 0.

iii) elasticity of demand at point 'D' < elasticity of demand at point 'C'

  Ans - the statement is true.

 

 

  at a lower level of price, lower segment tends to decrease while upper segment tends to increase. implying that elasticity of demand reduces as price tends to be lower than before.

ii) the statement is true.

  price = 0, at point B,

Ed at point B = O

                         AB  = 0

  Elasticity of demand  = 0, when price = 0.

iii) the statement is true . because 

elasticity of demand at point D is less than elasticity of demand at point c.

 Q- find own price elasticity of demand when 5 percent increase in price causes 5 percent increase in expenditure on the commodity.

Ans- it is a situation of zero own price elasticity of demand. because expenditure on the commodity is increasing proportionate to increase in price, so that total purchase of the commodity remains constant. constant purchase means zero elasticity of demand.

Q- why is demand for water inelastic?

Ans- demand for water is inelastic, as water is an essential of life.

 imp. factors affecting price elasticity of demand 

1. nature of commodity :- by nature of commodity demand 

A)  necessities of life :- the goods which are necessities have inelastic demand i.e. there demand is not much affected by price. for e.g. wheat, salt, vegetables, etc.

B) luxuries :-

the goods which are luxuries such as important cars fashionable garments costly furniture, AC etc. have elastic demand because their demand is much affected by price.

C) comforts :- the goods that are comforts to the life for e.g. fans, refrigerator etc. have neither very elastic nor inelastic demand.

D) jointly demanded goods :- like bread and butter, pen and ink show a moderate elasticity of demand.

2.  availability of close substitutes :-

the goods whose substitutes are available such as pepsi and coke have elastic demand where as goods whose sub are not available such as cigarettes, liquor etc. have inelastic demand.

3. different uses of commodity or diversity of uses :-

the goods which can be put to verity of uses have elastic demand for e.g. electricity, milk etc. if there price falls there demand increases much because people start using it in very less important uses. on the other hand if a commodity such as paper has only few uses, its demand is likely to be less elastic.

4. income of the consumer :-

the goods that are consumed by very high and very low income group people have inelastic demand. where as middle income group have elastic demand. for ex. demand of small cars by middle income group is elastic. where as demand of luxury cars is inelastic.

5. price level :-

if the price of a commodity is high its demand will be elastic and if price of commodity is very low then its demand is inelastic.

6. postponement of the use :-

the demand will be elastic for those commodities whose consumption can be postponed and vice - versa. such as demand of residential houses. people often defer their demand for residential houses when interest rates on loans are high.

7. habit of consumer :-

the goods to which a consumer become habitual have inelastic demand such as cigarette, liquor etc. because a person cannot live without them. on the other hand demand of cigarettes, liquor does not reduce even when these goods are heavily taxed.

importance of price elasticity of demand 

I) useful to a producer :-

every producer aims at maximizing his profits by promoting his sales. to increase the sales he reduces the price of more elastic goods and charges high price for less elastic goods .

II) useful to finance minister :-

the finance minister makes the use elasticity of demand by imposing taxes in the budget he fixes more taxes on inelastic commodities and less taxes on elastic commodities.

III) importance in factor prices :- 

if demand for factor price is inelastic than a factor will get high wages where as a factor will get lesser wages if demand for factors is more elastic.

IV) importance in international trade :-

it helps to determine trade between two countries. a country fixes more prices of the product whose demand is inelastic where as less price of the product whose demand is elastic.

v) useful to monopolist :-

for the monopolist the knowledge of elasticity of demand is essential. a monopolist will fix high price for those goods whose demand is inelastic less price for those goods whose demand is elastic.