Ceteris Paribus in Economics

Defintion of Ceteris Paribus

Ceteris Paribus is a latin phrase meaning 'all other things remaining equal' The concept of ceteris paribus is important in economics because in the real world it is usually hard to isolate all the different variables.

This idea leads into another basic tenet of economics. In any economic analysis, we
usually assume that everything outside of the problem at hand remains constant. For instance, some variables in our unemployment and inflation model will actually erase the tradeoff. This happened in the 1980s and 1990s in the United States, where there was low unemployment and low inflation at the same time. However, for the most part the model is almost always correct. Thus, for the purposes of examining those two variables, economists usually assume that all of the other possible variables effecting those remain the same. Economists call this ceteris paribus or the other things being equal assumption. When considering economics, it is helpful to first evaluate only two variables, and then to examine the effects of other upon the model. Clause One of the disciplines in which ceteris paribus clauses are most widely used is economics, in which they are employed to simplify the formulation and description of economic outcomes. When using ceteris paribus in economics, assume all other variables except those under immediate consideration are held constant. For example, it can be predicted that if the price of beef increasesceteris paribus the quantity of beef demanded by buyers will decrease. In this example, the clause is used to operationally describe everything surrounding the relationship between both the price and the quantity demanded of an ordinary good. This operational description intentionally ignores both known and unknown factors that may also influence the relationship between price and quantity demanded, and thus to assume ceteris paribus is to assume away any interference with the given example. Such factors that would be intentionally ignored include: the relative change in price of substitute goods, (e.g., the price of beef vs pork or lamb); the level of risk aversion among buyers (e.g., fear of mad cow disease); and the level of overall demand for a good regardless of its current price level (e.g., a societal shift toward vegetarianism). The clause is often loosely translated as "holding all else constant."

Characterization given by Alfred Marshall The clause is used to consider the effect of some causes in isolation, by assuming that other influences are absent. Alfred Marshall expressed the use of the clause as follows: o The element of time is a chief cause of those difficulties in economic investigations which make it necessary for man with his limited powers to go step by step; breaking up a complex question, studying one bit at a time, and at last combining his partial solutions into a more or less complete solution of the whole riddle. In breaking it up, he segregates those disturbing causes, whose wanderings happen to be inconvenient, for the time in a pound called Ceteris Paribus. The study of some group of tendencies is isolated by the assumption other things being equal: the existence of other tendencies is not denied, but their disturbing effect is neglected for a time. The more the issue is thus narrowed, the more exactly can it be handled: but also the less closely does it correspond to real life. Each exact and firm handling of a narrow issue, however, helps towards treating broader issues, in which that narrow issue is contained, more exactly than would otherwise have been possible. With each step more things can be let out of the pound; exact discussions can be made less abstract, realistic discussions can be made less inexact than was possible at an earlier stage. (Principles of Economics, Bk.V,Ch.V in paragraph V.V.10).

Two uses The above passage by Marshall highlights two ways in which the ceteris paribus clause may be used: The one is hypothetical, in the sense that some factor is assumed fixed in order to analyse the influence of another factor in isolation. This would be hypothetical isolation. An example would be the hypothetical separation of the income effect and the substitution effect of a price change, which actually go together. The other use of the ceteris paribus clause is to see it as a means for obtaining an approximate solution. Here it would yield a substantive isolation. Substantive isolation has two aspects: Temporal and causal. Temporal isolation requires the factors fixed under the ceteris paribus clause to actually move so slowly relative to the other influence that they can be taken as practically constant at any point in time. So, if vegetarianism spreads very slowly, inducing a slow decline in the demand for beef, and the market for beef clears comparatively quickly, we can determine the price of beef at any instant by the intersection of supply and

demand, and the changing demand for beef will account for the price changes over time (Temporary Equilibrium Method). The other aspect of substantive isolation is causal isolation: Those factors frozen under a ceteris paribus clause should not significantly be affected by the processes under study. If a change in government policies induces changes in consumers' behavior on the same time scale, the assumption that consumer behavior remains unchanged while policy changes is inadmissible as a substantive isolation (Lucas critique).

It's when you hold one variable constant to review how changes in the economy would be effected. For instance if you're trying to look at unemployment and you want to see how changes in pricing affect labor, then you'd need to hold (ceteris parabis) all other factors the same such as supply of the labor force, market value of the item, etc. to see the relationship between only unemployment and pricing. This is just an example but hopefully this helps. Source(s): B.S. in Economics suppose increase in income; ceteris paribus (including consumer preference, price of substitute goods are unchanged), increase in income will increase (say) demand for good X; ceteris paribus is an assumption that one variable is changed while others are constant; though in reality it does not make sense but it's use in theory just an assumption for simplicity purpose; in reality, there r many factors affecting Source(s): economics reader and took economics course before

Example of Ceteris Paribus in Economics An increase in interest rates will 'ceteris paribus' cause demand for loans to fall. Higher interest rates increase the cost of borrowing so there will be less demand for loans. However, if confidence was high, people might still want to borrow more. Ceteris paribus assumes things like confidence remain the same.

 Ceteris paribus is an essential feature of the scientific method and economic analysis. Implementing the ceteris paribus assumption makes it possible to isolate the effect one factor has on another in the derivation and testing of hypotheses and principles. Scientific Method The scientific method seeks to explain the way the world works by testing and verifying hypothesized cause-and-effect relations. Such relations take the form of "If A, then B." Or that "Event A causes event B." To identify the connection between A and B it is essential that only A and B change. If event A is hypothesized to cause event B, then other possible events C, D, and E, which might affect B, cannot be allowed to change, cannot be allowed to influence B. Consider a basic economic principle, the law of demand. This law states that quantity demanded is inversely related to demand price. Or stated in other terms, an increase in demand price causes a decrease in quantity demanded. Suppose, for example, that focus is on the demand for hot fudge sundaes, particular the law of demand for hot fudge sundaes. The amount of hot fudge sundaes that buyers are willing and able to purchase, however, can be influenced by factors other than the price of hot fudge sundaes, including income, preferences, or the prices of other goods.

Demand Price Changes: Suppose that the price of hot fudge sundaes increases from $2 to $3. The law of demand indicates that the quantity demanded of hot fudge sundaes should decrease.

Quantity Demanded Changes: If the quantity demanded of hot fudge sundaes decreases, then this provides (presumably) confirmation of the law of demand. But what if the quantity demanded increases? Does this refute the law of demand?

Other Factors: The law of demand cannot be confirmed or refuted if other factors that also influence hot fudge sundae demand also change. Suppose hot fudge sundae buyers have more income, which they are inclined to spend on hot fudge sundaes. Additionally, suppose the price of yogurt cones (a substitute for hot fudge sundaes) increases, prompting potential yogurt cones buyers to purchase hot fudge sundaes instead.

With these other factors also changing, testing the cause-and-effect connection between demand price and quantity demanded is impossible. It is not possible to say for certain if the change in the quantity demanded of hot fudge sundaes is caused by the higher price of hot fudge sundaes or by the change in buyers' income or by the change in the price of yogurt cones. Using the scientific method to derive, test, and verify hypotheses, requires the ceteris paribus assumption, that other factors be kept constant.

Economic Analysis Although other factors are initially held constant with the ceteris paribus assumption, they are not necessarily held constant forever. A critical aspect of economic analysis is to systematically relax the ceteris paribus assumption. In so doing, the specific effect of each ceteris paribus factor can be identified and analyzed. Much like a chemist adds one chemical at a time to a mixture to determine the resulting reaction, an economist relaxes one ceteris paribus assumption at a time to observe the results. Consider once again the demand for hot fudge sundaes. Once the law of demand is identified and combined with the supply of hot fudge sundaes, then the hot fudge sundae market can be analyzed. The equilibrium price and equilibrium quantity can be identified. This equilibrium, however, is based on the ceteris paribus assumption. In particular, other demand factors, such as buyers' income, preferences, and other prices, are held unchanged in the identification of the equilibrium. What happens to the price and quantity of hot fudge sundaes should one of these ceteris paribus factors change? Suppose, for example, that buyers have more income. By relaxing the ceteris paribus assumption of constant income, the effect of an increase in buyers' income on the hot fudge sundae market can be analyzed. The effect of other ceteris paribus factors can subsequently be analyzed as well, one by one. This systematic analytical approach can provide a great deal of insight into the operation of the hot fudge sundae market.