Sources
Help build the largest human-edited directory on the web.
Submit a site - Become an editor
Wikipedia. Licensed under the GNU Free Documentation License.
Are you an expert in this subject? Join the discussion and share your knowledge at Wikipedia.org.
Competitive equilibrium
From Wikipedia, the free encyclopedia
 |
This article is uncategorized.
Please help improve this article by adding it to one or more categories, so it may be associated with related articles (how?). Please remove this tag after categorizing, but not before. |
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 such small compared to the total quantity traded in the market that their individual transactions have no influence on the prices.
A competitive equilibrium consists of a 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 product, bananas and apples, and 2 individual, Jane and Kelvin. The price of banana is Pb, and the price of apple is Pa.
The indifferent 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 Pb and Pa. After trading both Jane's and Kelvin's indifferent curves move to more satisfactory level, J2 and K2. The new indifference curves intersect at point E. The slop 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 individual society reach Pareto Efficiency, where there is no way to make Jane or Kelvin better off without making the other worse off.