Meta: Understand some of the economic terms we often hear but rarely understand.
Ceteris Paribus: Understanding This Essential Economics Term
Many feel that economics is an area which does not affect them. In fact, it affects everyone’s daily life, regardless of age.
When we cast our votes to choose the government we want in power, we should always be aware of their economic views. They are the ones who will have the ability to change how the economy affects us.
You don’t have to study for a Masters Degree in economics, but you should have a basic understanding of the topic. We actually hear many economic terms in the news on a daily basis, including phrases such as fiscal policy and Ceteris Paribus, but do we really understand them?
This article aims to give you a clearer understanding of Ceteris Paribus. This understanding will empower you with better knowledge about one of the most common economic terms used.
What Does Ceteris Paribus Mean?
This phrase is derived from Latin. It means “holding other things constant.” It is also often translated as “all else being equal.”
Ceteris Paribus is a dominant assumption in general economic thinking. It acts as a shorthand explanation of the impact of one variable over another. This is providing that all other variables remain the same.
It is a phrase and theory often referred to when composing arguments related to cause and effect.
Economists may say Ceteris Paribus:
Many economists rely on it to test and build economic models, which means they hold all the variables of the model constant and play around with them individually.
Ceteris Paribus does have limitations. Most notably, when such arguments pile on top of each other. Yet, it is an essential way of describing comparative tendencies in markets.
Assumptions of Ceteris Paribus help to change a social science. They change it from one that is deductive into one that is positive.
This is done by creating an imaginary structure of rules and conditions. Economists use these to then seek a specific end.
Or, you could say it helps them bypass human nature and the problems of constrained knowledge.
The Development of Ceteris Paribus
Economic principles start as deductions from logical observations. The resources they have are scarce. Individuals often prefer the present good over a future good.
Economists make their decisions on the margin. With each successive good, there is a decline in marginal utility. This means the value is determined subjectively.
Mainstream economics moved from a deductive to a positivistic social science. This change followed the release of two very important publications.
Leon Walras introduced economics to the general equilibrium theory, and John Keynes’ publication saw the creation of macroeconomics.
Economists started to become serious about math. They did this to make the field more like chemistry and physics, which had greater academic respect.
A major problem they had was variable uncertainty. Economists had difficulty isolating independent and controlled variables for the math equations. Another challenge was the method, which includes isolating specific variables. As well as testing their interrelatedness, this is used to prove or disprove a hypothesis.
Economics is generally incompatible with scientific methods. There isn’t a single economist who is able to control all actors, nor can they hold their actions constant to be able to run specific tests.
No economist is even able to identify the critical variables within a given economy. There could be dozens, or hundreds, of independent variables for each economic event.
That is where Ceteris Paribus comes in. Economists build hypothetical models, where they imagine all variables are held constant. The exception being the variable they want to test.
This style is called Ceteris Paribus and is the heart of general equilibrium theory.
They pretend that all variables apart from one are held constant. Economists are then able to remodel relative deductive market trends into mathematical sequences.
The Use of Ceteris Paribus in Economics
As an example, if an economist decided to prove that minimum wage laws cause unemployment, or that easy money will cause inflation, it would be impossible to set up two test economies that were identical. It would also be difficult to start printing money and introduce a minimum wage.
For these reasons, the economist has to create a suitable structure for the scientific method. This could mean making some very unrealistic assumptions.
Economists would assume that buyers and sellers are price-takers and not price makers. They would also conclude that the actors have absolute information about their choices. Uncertainty, or an incorrect decision based on inadequate information, would create a loophole in the model.
If the models formed seem to give accurate predictions in the real world, then they are considered successful. If the predictions don’t appear accurate, they will be revised.
Positive economics can be tricky, as a model may look positive one year but the year after it could be incorrect. This is why some economists reject positivism. They choose to instead embrace deduction as their principle system of discovery.
The majority accept the parameters of Ceteris Paribus assumption. This makes the field more like chemistry and takes it further away from philosophy.
Arguments Against the Use of Ceteris Paribus in Economics
At the heart of many macroeconomic and microeconomic models is Ceteris Paribus. Some critics point out that this gives economists the excuse to evade the real problems of human nature.
Economists have admitted that the assumptions are unrealistic. Yet these are the models that have led them to ideas such as cross elasticity, utility curves, and monopoly.
Some feel that Ceteris Paribus assumption has been taken too far. These people believe it has transformed economics from a useful and logical social science into a series of mathematical problems.
A popular use of Ceteris Paribus is for supply and demand. Static supply and demand charts feature in most introductory books for microeconomics.
They show prices which are given to the consumer and to the producer. A step which is necessary especially within this framework. This allows economists to assume away the complexities of the price discovery process.
In the real world, prices are not separate entities of consumers and producers. In fact, the producers and consumers themselves will determine the prices. They base this on how much they value the product in relation to the quantity of money it is being traded for.
There are many other factors, as well as the prices, which affect the economy or finances. They are continuously in transition. The Ceteris Paribus principle is good for independent tests and studies.
Yet, when it comes to the market, there are so many factors that affect the prices of stocks that it would be impossible to isolate one, as they can change frequently, and often do. So, for this purpose, to assume “all other things being equal” would not be the most effective approach.
Is Mutatis Mutandis the Same as Ceteris Paribus?
Mutatis Mutandis also comes from Latin and translates as “once necessary changes have been made.” While it uses similar assumptions to Ceteris Paribus, it should not be confused with it.
Mutatis Mutandis acknowledges that comparables require certain necessary alterations to be left unsaid, due to their obviousness. The same goes when comparing two variables.
In contrast to this, Ceteris Paribus eliminates all changes. This is except for the ones which have been explicitly spelled out.
You are more likely to encounter Mutatis Mutandis when considering counterfactuals. It is used as a shorthand to illustrate initial and formulated changes. These are things that are assumed to be obvious or have been discussed before.
Correlation and causation are the main differences between these two:
Enables the study of the causal effect of one variable on another.
Aids analysis of the correlation between effects of variables where other variables will change at will.
Economics is not an easy subject. If it is an area you're interested in learning about, there are many resources available for you to do so. The world of economics can have a major impact on our lives. Learning some of the basics should be on everyone’s to-do list.
Every day, we place our trust in governments to make the right decisions about our economy. In turn, they rely on economists to provide them with the right information.
We often read articles in newspapers or hear stories on the news about the economy. There are many different terms used in these channels. However, our understanding of what they are talking about is often limited.
Through learning more about essential economic terms you are educating yourself. It will help you gain a better understanding of how governments manage our economy. So, expand your knowledge by accessing the hundreds of resources available online.