Competitive market equilibrium is an economic concept detailing the relationship that exists between the demand of consumers and the supply of producers. At a certain point, supply equals demand and forms the price point for a particular good or service, and this point is known as equilibrium. If there are changes in levels of supply or demand, the price point will either rise or fall in accordance with these changes until equilibrium is reached once again. The concept of competitive market equilibrium relies on a free market with many firms selling goods in an attempt for profits, as opposed to a monopoly with one firm controlling production or a market controlled by a centralized government.
Free markets are those economic markets where a multitude of producers create goods and services for people to purchase. Consumers in these markets have choices about what goods to purchase and what price they are comfortable paying for those products. All of this activity will result in a point where price levels stabilize according to supply and demand. At this point, competitive market equilibrium is reached.
The easiest way to see how competitive market equilibrium is achieved is to study a graph depicting the production levels of a certain product, the prices at which they are sold, and the demand by consumers for this product. Lines on the graph depicting supply and demand may rise and fall depending on price changes. At some point, these lines will intersect, resulting in the equilibrium between supply and demand.
Changes in the levels of supply and demand can affect competitive market equilibrium. For example, a sudden rise in demand for a certain product will cause firms to increase production to meet the excess demand. To deal with the costs of increased production, firms will raise the prices of the product. At a certain level, the higher prices will keep consumers from buying and demand will fall, leaving excess supply. Prices will drop back down until a new equilibrium is reached.
Such a harmonious relationship between supply and demand only exists in a competitive marekt. As a result, competitive market equilibrium will not be achieved in a market that does not have perfect competition. Any economy where production and prices are set by a centralized government lacks equilibrium. In addition, a market dominated by one or a few firms will not have equilibrium, largely because the dominant firms will have more leverage to set price points that consumers must accept.