Competitive Equilibrium - Explained
What is Competitive Equilibrium?
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Table of ContentsWhat is Competitive Equilibrium?How does Competitive Equilibrium Work?How it Work (Example)Uses of Competitive EquilibriumCompetitive Equilibrium vs. General EquilibriumAcademic Research on Competitive Equilibrium
What is Competitive Equilibrium?
Competitive equilibrium is a traditional concept where the interaction of market forces such as demand and supply responds to prices, while prices respond to demand and supply. This type of equilibrium relies on the competitive environment theory. It is where every trader decides on a small quantity compared to that of the total quantity traded in the market. These individual transactions by the traders, in most cases, do not have any influence on the prices.
How does Competitive Equilibrium Work?
Competitive equilibrium refers to a states market, characterized by a set of prices, including commodities allocation. At equilibrium prices, each agent is usually able to maximize his or her objective function subject to:
- Resource constraints
- Technological limitations
- Market supply
- Demand for the specific products
The basic supply and demand model is based on the firms behavior and an individual consumer. However, when it comes to the competitive equilibrium model, it is based on consumer aggregate behavior and companies in competitive markets. In economics, you can look at competitive equilibrium is the form of specialized branch theory that deals with decision making in the big markets.
How it Work (Example)
Lets assume that a manager in the market announces a price. Then, each participant indicates whether or not she wishes to purchase or sell at that particular price. If the demand does not equal the supply, then the manager has no choice but to change the price. The manager who decides to do this is known as Walrasian auctioneer. However, in most cases, there are no such people who are willing to play the Walrasian auctioneers role. However, when you look at various experiments, there is evidence that competitive equilibrium is indeed a good predictor of different market outcomes. There is also an argument that competitive models work well when there is a large number of traders. Nonetheless, experiments have shown that even with few traders, the competitive method can also perform well.
Uses of Competitive Equilibrium
- Traders can use competitive equilibrium to predict the total quantity in the market and the equilibrium price, including the quantity that each individual consumes and output per company.
- It is also used to analyze economic activities to do with tax or fiscal policy, in finance for the purpose of analyzing the following:
- Stock market
- Commodity markets
- Study interests
- Exchange rates
- Economists can also use competitive equilibrium as a benchmark for efficiency during the economic analysis.
- It is considered as a standard measure for evaluating other market structure.
Competitive Equilibrium vs. General Equilibrium
One major feature that defines competitive equilibrium is that it is competitive. However, the defining characteristic of the general equilibrium is that it is applied to more than one market. It is contrary to the partial equilibrium, where you hold at least one fixed price and analyze the market prices response only. So, any general equilibrium can be a competitive equilibrium, but any competitive equilibrium cannot be necessarily general equilibrium.