E. Equilibrium in Competitive Markets

This section of the Handbook covers the theory of equilibrium in competitive markets. A market is termed competitive if there are many suppliers (firms) and consumers, none of whom is big enough to be able to individually affect the price of the good or service traded in the market. The equilibrium price in a market is the price at which the quantity of the commodity that consumers choose to demand equals the quantity that firms choose to supply. This quantity is called the equilibrium quantity.

The theory is divided into two main parts. The first part focuses on the notion of partial equilibrium, that is, equilibrium in a single market with the prices in all other markets held fixed. We look at the determinants of equilibrium price and quantity in the short run (when firms cannot enter or exit the industry) as well as in the long run (when firms are able to do either). We also look at how interventions such as taxes, subsidies or quotas affect the equilibrium price and quantity.

The second part of the theory focuses on the notion of general equilibrium, that is, a situation where all markets clear simultaneously taking into account the fact that prices in some markets affect the demand and supply in others.

We also define and examine the important concept of the efficiency of markets, and how competitive markets achieve this property. We also look at how interventions such as taxes, subsidies or quotas impact efficiency. This type of study is called welfare analysis.