What is 'Competitive Equilibrium'

A competitive equilibrium is an equilibrium condition where the interaction of profit-maximizing producers and utility-maximizing consumers in competitive markets with freely determined prices arrive at an equilibrium price. At this equilibrium price, the quantity supplied is equal to the quantity demanded.

BREAKING DOWN 'Competitive Equilibrium'

While the basic supply and demand model is based on individual consumer and firm behavior, the competitive equilibrium model is based on the behavior of aggregate consumers and firms in competitive markets. It can be used to predict the equilibrium price and total quantity in the market, as well as the quantity consumed by each individual and output per firm.

Competitive equilibrium is a state of market, characterized by a set of prices and an allocation of commodities, such that at equilibrium prices, each agent maximizes his objective function subject to his technological limitations and resource constraints, and the market clears the aggregated supply and demand for the products in question.

Competitive equilibrium theory can be considered as a specialized branch of game theory that deals with making decisions in large markets. It is used extensively to analyze economic activities dealing with fiscal or tax policy, in finance for analysis of stock markets and commodity markets, to study interest, and exchange rates and other prices. It serves as a benchmark for efficiency in economic analysis. It relies on the assumption of competitive markets, where each trader decides upon a quantity that is so small compared to the total quantity traded in the market, such that their individual transactions have no influence on the prices. Competitive markets are an ideal, and a standard by which other market structure are evaluated.

In a capitalist market, vital regulatory functions, such as ensuring stability, competency and fairness are left to the mechanisms of pricing. Thus, competitive equilibrium theory of equilibrium prices acquired a prominent place in mathematical economics. With the advent of the Internet, extensive research has been done at the intersection of computer science and economic theory.

Competitive Equilibrium vs. General Equilibrium

The defining characteristic of competitive equilibrium is that it's competitive. By contrast, a general equilibrium's defining characteristic is that it is an equilibrium on more than one market; as opposed to the partial equilibrium in which we hold at least one price fixed and analyze the response of other markets/prices only. The difference between the two types of equilibriums is all about the emphasis. Any general equilibrium is a competitive equilibrium, but not any competitive equilibrium is necessarily general equilibrium.

RELATED TERMS
  1. General Equilibrium Theory

    General equilibrium theory studies supply and demand fundamentals ...
  2. Equilibrium

    Equilibrium state in which market supply and demand balance each ...
  3. Radner Equilibrium

    A theory suggesting that if economic decision makers have unlimited ...
  4. Recursive Competitive Equilibrium ...

    An equilibrium concept associated with dynamic programs. Recursive ...
  5. Neoclassical Growth Theory

    The neoclassical growth theory is an economic concept where equilibrium ...
  6. Lindahl Equilibrium

    Lindahl equilibrium is the price paid by an individual for his ...
Related Articles
  1. Investing

    What is Deadweight Loss?

    Deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  2. Insights

    Introduction to Supply and Demand

    Learn about one of the most fundamental concepts of economics - supply and demand - and how it relates to your daily purchases.
  3. Trading

    An Introduction To J-Charting

    Learn about a technical tool that's based on the view that markets are energetic systems.
  4. Insights

    What is Microeconomics?

    Microeconomics deals with individual and small business economic decisions.
  5. Investing

    Effect of Fed Fund Rate Hikes on Oil

    Find out how oil markets might react to an interest rate hike by the Federal Reserve, and why consumers and bondholders could love a rising interest rate.
  6. Trading

    Tiger Trading: Long-Term Charts For Short-Term Currency Trades

    Stock traders can add currencies to their portfolios by using this patient investing strategy.
  7. Insights

    Competitive Advantage Counts

    What's the best indicator of a company's future success? Its ability to succeed when others fail.
RELATED FAQS
  1. Why are there no profits in a perfectly competitive market?

    See why economic profits are theoretically impossible in a perfectly competitive market and why some economists use perfect ... Read Answer >>
  2. Why is game theory useful in business?

    The concepts of game theory became a revolutionary interdisciplinary phenomenon, but they are still relevant for business ... Read Answer >>
  3. What is a common strategy traders implement when using the Price Rate Of Change (ROC)?

    Learn a straightforward trading strategy for trend following commonly used by traders implementing the price rate of change ... Read Answer >>
Hot Definitions
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  2. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  3. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  4. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  5. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  6. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
Trading Center