Competitive Equilibrium

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Definition: Competitive Equilibrium

Competitive equilibrium is defined as the price at which producers and consumers interact and agree to exchange products in a free market. Here the objective of producer is to maximize its profit while the objective of consumer is to maximize its utility.

Assumption: Competitive Equilibrium (also called Walrasian Equilibrium) works on the assumption that the quantity decided by each of the producer is so small compared with the overall quantity from all producers that their individual transaction does not create any impact on the overall commodity structure.

Competitive equilibrium is defined by two factors:

i. Price factor: price of each of the commodity

ii. Allocation factor: the quantity of each commodity allocated to each seller.

Now, following conditions need to be satisfied to obtain competitive equilibrium:

i. The total demand of each commodity should be equal to the total supply of that commodity. This is called feasibility condition.

ii. In the given budget of each seller, he must get the best possible combination of commodities. This is called rationality condition.

iii. Each of the commodity which has positive price must be fully allocated.


In all the following examples, we assume that the item is indivisible. Now, let’s say I have a book whose utility for me is 100 and utility for you is 150. Now, if you offer me any money less than 100, I will not give you the book because my utility will decrease. Similarly if I demand more than 150 from you, you will not buy the book from me. But, if you offer me any amount between 100 to 150 (let’s say 120), I will give you the book because in that case, both of us are increasing our utility. This is called the state of competitive equilibrium. Please note that it may not be possible to achieve competitive equilibrium in some cases where the utility of both of the parties are decreasing in a transaction.



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