WASHINGTON (AP) _ Students will compete in designing a digital system to replace 23 million talking books and magazines and 730,000 cassette playback machines that the Library of Congress lends to the blind and others who can't read because of physical disabilities.

Existing digital machines made in Canada and Japan do not meet the need, said Robert Fistick, spokesman of the National Library Service for the Blind and Physically Handicapped.

Nearly a million machines will be produced and lent out in the first 10 years of the program.

Prizes of $5,000 will go to the winning design, $2,000 to the design taking second place and $1,000 for third place. They will be presented next July by the Industrial Designers Society of America. The group is organizing the competition among its 54 affiliated schools.

``Present equipment will not all be junked,'' said Fistick. ``Some people will want to keep the cassette equipment, just as there are still a few who use the older system with long-playing records.''

The library's talking books program goes back to 1933. About 7 million of its 120 million books and other items are already on line in digital form.