- Competitive equilibrium
Competitive market equilibrium is the traditional concept of economic equilibrium, appropriate for the analysis of commodity markets with flexible prices and many traders, and serving as the benchmark of efficiency in economic analysis. It relies crucially on the assumption of a competitive environment where each trader decides upon a quantity that is so small compared to the total quantity traded in the market that their individual transactions have no influence on the prices. Competitive markets are an ideal, a standard that other market structures are evaluated by.
A competitive equilibrium is a vector of prices and an allocation such that given the prices, each trader by maximizing his objective function (profit, preferences) subject to his technological possibilities and resource constraints plans to trade into his part of the proposed allocation, and such that the prices make all net trades compatible with one another ('clear the market') by equating aggregate supply and demand for the commodities which are traded.
A simple example is a society where there are only 2 products, bananas and apples, and 2 individuals, Jane and Kelvin. The price of bananas is Pb, and the price of apples is Pa.
The indifference curves J1 of Jane and K1 of Kelvin first intersect at point X, where Jane has more apples than Kelvin does, Kelvin has more bananas than Jane does, and they are willing to trade with each other at the prices Pb and Pa. After trading both Jane and Kelvin move to an indifference curve which depicts a higher level of utility, J2 and K2. The new indifference curves intersect at point E. The slope of the tangent of both curves equals -Pb/Pa.
And the MRSJane=Pb/Pa; MRSKelvin=Pb/Pa. The marginal rate of substitution of Jane equals that of Kelvin. Therefore the 2 individuals society reaches Pareto efficiency, where there is no way to make Jane or Kelvin better off without making the other worse off.
The competitive equilibrium and allocative efficiency
At the competitive equilibrium, the value society places on a good is equivalent to the value of the resources given up to produce it (marginal benefit equals marginal cost). By definition, this ensures allocative efficiency (the additional value society places on another unit of the good is equal to what society must give up in resources to produce it).
Note that microeconomic analysis does NOT assume additive utility nor does it assume any interpersonal utility tradeoffs. Efficiency therefore refers to the absence of Pareto improvements. It does not in any way opine on the fairness of the allocation (in the sense of distributive justice or equity). An 'efficient' equilibrium could be one where one player has all the goods and other players have none (in an extreme example). This is efficient in the sense that one may not be able to find a Pareto improvement - which makes all players (including the one with everything in this case) better off (for a strict Pareto improvement), or not worse off.
- ^ Callan, S.J & Thomas, J.M. (2007). 'Modelling the Market Process: A Review of the Basics', Chapter 2 in Environmental Economics and Management: Theory, Politics and Applications, 4th ed., Thompson Southwestern, Mason, OH, USA
Wikimedia Foundation. 2010.
Look at other dictionaries:
Recursive competitive equilibrium — In macroeconomics, recursive competitive equilibrium (RCE) is an equilibrium concept. It has been widely used in exploring a wide variety of economic issues including business cycle fluctuations, monetary and fiscal policy, trade related… … Wikipedia
Recursive Competitive Equilibrium - RCE — An equilibrium concept associated with dynamic programs. Recursive competitive equilibrium (RCE) is characterized by time invariant equilibrium decision rules that specify actions as a function of a limited number of state variables, which… … Investment dictionary
Equilibrium — is the condition of a system in which competing influences are balanced and it may refer to:cienceBiology* Equilibrioception, the sense of balance present in humans and animals * Homeostasis, the ability of an open system, especially living… … Wikipedia
Competitive Equilibriums — An equilibrium condition where the interaction of profit maximizing producers and utility maximizing consumers in competitive markets with freely determined prices will give rise to an equilibrium price. At this equilibrium price, the quantity… … Investment dictionary
Competitive heterogeneity — is a concept from strategic management that examines why industries do not converge on one best way of doing things. Microeconomics predicts that competition will result in industries composed of identical firms offering identical products at… … Wikipedia
Competitive Lotka–Volterra equations — The competitive Lotka–Volterra equations are a simple model of the population dynamics of species competing for some common resource. They can be further generalised to include trophic interactions. Contents 1 Overview 1.1 Two species 1.2 N… … Wikipedia
Competitive Pricing — Setting the price of a product or service based on what the competition is charging. Competitive pricing is used more often by businesses selling similar products, since services can vary from business to business while the attributes of a… … Investment dictionary
General equilibrium — theory is a branch of theoretical microeconomics. It seeks to explain the behavior of supply, demand and prices in a whole economy with several or many markets. It is often assumed that agents are price takers and in that setting two common… … Wikipedia
Economic equilibrium — Price of market balance: P price Q quantity of good S supply D demand P0 price of market balance A surplus of demand when P<P0 B surplus of supply when P>P0 In economics, economic equilibrium is a state of the world where economic forces… … Wikipedia
Radner Equilibrium — A theory suggesting that if economic decision makers have unlimited computational capacity for choice among strategies, then even in the face of uncertainty about the economic environment, an optimal allocation of resources based on competitive… … Investment dictionary