Producer’s equilibrium or optimisation occurs when he earns maximum profit with optimal combination of factors. A profit maximisation firm faces two choices of optimal combination of factors (inputs).
1. To minimise its cost for a given output; and
2. To maximise its output for a given cost.
Thus the least cost combination of factors refers to a firm producing the largest volume of output from a given cost and producing a given level of output with the minimum cost when the factors are combined in an optimum manner. We study these cases separately.
In the theory of production, the profit maximisation firm is in equilibrium when, given the cost-price function, it maximises its profits on the basis of the least cost combination of factors.
For this, it will choose that combination which minimizes its cost of production for a given output. This will be the optimal combination for it.
Of course, profit depends on revenue and cost. As a result of this, the concept of producer equilibrium revolves around revenue and cost. According to the MR-MC approach, a producer is said to be in equilibrium when:
1] MR=MC
As long as the cost of producing another unit remains less than the revenue received from the sale of an additional unit, a producer won’t wander away from his path of earning profits. This is because, until MR>MC, it keeps on adding to profits. Production is stopped only when MR becomes equal to MC.
MR is the addition to TR from the sale of one more unit. MC is the addition to TC when an additional unit is produced. Thus when MR=MC, TR-TC becomes maximum for maximum profit. If MR exceeds MC, then the producer will continue producing as it will add to his profits.
On the contrary, if MR<MC then benefit will be less than cost. In essence, MR=MC is the only possible combination among the three to represent equilibrium.
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