Marginal Revenue and Marginal Cost approach (MR-MC approach)

2. Marginal Revenue and Marginal Cost approach:-

MR-MC approach is a very important and useful method for determining the equilibrium of the firm. Under this approach, the following conditions must be fulfilled to attain equilibrium by the firm.

i. Necessary condition:-
Marginal revenue should be equal to Marginal Cost i.e. MR=MC.

ii. Sufficient condition:-
Marginal Cost curve must intersect the Marginal Revenue curve from below.

The MR-MC approach of determining equilibrium under the perfect competition and monopoly is explained as follows:-

A. Equilibrium of a firm under perfect competition:-

Perfect competition is characterized by a large number of buyers and sellers. Firms produce homogeneous goods and they are taken as the price takers. In this market, the firm has no control over the price. It must sell the products at that price which is determined by the industry. So, the price remains uniform. Therefore, the AR curve and MR curve are the same and parallel to X-axis. MC curve is U-shaped. The determination of equilibrium of a firm under perfect competition using this approach can be shown graphically as follows:-

In the above figure, MR and MC represent Marginal Revenue and Marginal Cost curve. MC equals MR at point A and points E which fulfills the necessary condition. Point E fulfills both necessary and sufficient condition. So, Point 'E' is the equilibrium point and OQ2 is the equilibrium level of output.

B. Equilibrium of a firm under monopoly or imperfect competition:-

In the monopoly market, the firm is the price maker. It can sell less output at a high price and more output at a low price. So, AR and MR curves slope downward. The MC curve is U-shaped. The equilibrium of the firm under monopoly using MR-MC approach can be explained by the help of the following diagram:-

In the above figure, MR represents the Marginal Revenue curve which is downward sloping and MC represent Marginal Cost curve which is U- Shaped. The point 'E' is the equilibrium point because, at this point, MC equals MR and MC cuts MR from below. So, the firm is in equilibrium at OQ level of output and can maximize its profit.