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Ceteris Paribus: Definition, Pros, Cons & Examples

Written by Paul Boyce Posted in Macroeconomics
Last Updated February 17, 2023

Ceteris Paribus meaning

Ceteris Paribus is a phrase used in economics that makes economic analysis simpler. In essence, it means ‘other things equal’. With regards to economics, it assumes that other influencing factors are held constant.

Ceteris paribus is where all other variables are kept equal. For example, if the price of Coca-Cola falls, ceteris paribus, its demand will increase. It means that other factors are not considered, or are considered to remain constant. Pepsi may react and reduce their prices as well, which may mean demand remains unchanged.

Key Points

Ceteris Paribus looks at the connection between two variables whilst assumption the other variables are consistent.
Economists use it to make economic analysis easier and create a basis by which to start.
Ceteris Paribus assumes all things are equal and whilst this infrequently happens in the real world, it can help explain a strong relationship between two variables. For instance, supply and demand.

Alternatively, Coca-Cola may have to compromise on the quality of their ingredients to reduce prices. In turn, this may lead to a decline in demand over the long-term. So, in conclusion, ceteris paribus is the simplification of an economic argument.

Usually, it is applied because there are many unknown factors or factors that cannot be considered accurately into the equation. By keeping other variables constant, we are able to make some form of analysis.

Why is Ceteris Paribus Important in Economics

Ceteris paribus is important in economics as it helps us develop some form of understanding of economic mechanisms. In other words, it allows us to form a basic understanding and principle by which we can build on.

One of the classic examples of ceteris paribus is the supply and demand curve. As prices increase (ceteris paribus), demand falls. Now we can accept this fact when all other things are equal. However, there are also other factors such as the price of substitutes, taxes, economic climate, and so on.

By applying ceteris paribus, we have a base to work from. Then we can start applying other factors and looking at the impact they would have. After all, we are only human and we do have cognitive limitations. We cannot plausibly factor in all variables.

“Ceteris paribus simplifies economic analysis by looking at the most influential variables.”

Ceteris paribus is also important because it allows economists to identify a relationship. Although there may be other variables, there may be one overwhelming factor that has a direct correlation with another. For instance, the theory of supply and demand.

Whilst there are a plethora of other variables, the most common explanation for a decline in demand is the price. In the same fashion, supply will tend to increase when demand rises. The normal supply and demand mechanisms work 95 percent of the time.

They help us explain economic actions most of the time and it’s for that reason that ceteris paribus is important. Without assuming other factors are consistent, we would not have developed a basic understanding of economics.

Ceteris Paribus Examples

Ceteris paribus is an economic term where all other variables are kept constant. Examples include interest rates, the minimum wage, and higher taxes. When examining each of those, economists must often assume ceteris paribus in order to create some meaningful insight – due to the complexity and number of other variables.

1. Interest Rates

When the interest rate increases (ceteris paribus), demand for debt goes down, as the cost of borrowing increases.

What is not considered is the wider economy. For instance, if businesses are doing well and looking to expand, an increase in the interest rate is unlikely to hold them back from borrowing.

Furthermore, high-interest rates may come in at a time whereby the money supply has grown rapidly. When the money supply is growing rapidly, inflation usually results. If people come to expect inflation, they will also expect the real value of their debt to increase.

Whilst there are other factors that will drive demand for debt, the interest rate is the most influential. It is for that reason economists use ceteris paribus. We can logically conclude that higher interest rates will decrease the demand for debt. However, it is equally important for us to conclude that this may not always be the case.

2. Minimum Wage

When the minimum wage increase (ceteris paribus), demand for such workers will decrease. The logic is that employers will have to pay their employees more, so will hire fewer of them.

What is not considered is the growth of the economy. When the wider economy is growing, we see industries that rely on minimum wage employees’ boom. For example, restaurants, retail, and fast food tend to see a pickup in demand as consumers eat out and spend more.

In turn, demand for employees has to grow, whether the wages are higher or not. In fact, it could be argued that wages would naturally go up anyway.

We also need to consider the fact that employers may pay a higher minimum wage but cut back on other benefits such as overtime pay or bonuses. So the demand for workers may go up, but they receive fewer employment benefits.

As we can see, there is more to the minimum wage than a simple supply and demand chart. At the same time, it provides economists with a basis to work from. Supply and demand theory would dictate that higher wages lead to lower demand. Yet what other variables are there that would mitigate these effects?

If we start from the theory, we can either identify variables that prove it would not work in current circumstances. Or, that in these circumstances, it would work.

3. Higher Taxes

If the government taxes people more, it receives more money. For instance, if the rate of income tax goes from 20 percent to 25 percent, the government should bring in more money. This is based upon ceteris paribus, where no other variables change.

What is not considered is the impact on individuals, particularly rich individuals. They may leave the country altogether and what they contribute in taxes as well.

Or, higher taxes might come at a time of economic decline. So people are losing their jobs and they aren’t spending so much. In turn, this may contribute to lower taxes by itself.

There are many other factors, but unlike the previous examples, tax receipts are more sensitive to other variables. In other words, higher taxes are only one small factor in a list of many. For instance, the economy is a better predictor of how much money the government would receive.

Advantages of Ceteris Paribus

One of the benefits of Ceteris Paribus is that it can simplify complex economic issues. For example, when taxes rise, we would expect government to bring in more money. However, there are a large number of reasons why this might not actually be the case. People might be losing their jobs, consumers might be spending less, and inflation might be eroding away the real value of its income.

In essence, ceteris paribus sets up a starting point for economic discussion and policy making. For instance, governments might want to help improve the lives of those in the lower income brackets. One potential solution is to raise the minimum wage which would, ceteris paribus, bring them a greater level of income.

If minimum wage workers have a higher level of income, their living standards will improve – assuming everything else remains the same. This is the point of ceteris paribus. It sets up a basis for economic discussion. So then we would consider what are the other factors which would prevent such a scenario from occurring.

Disadvantages of Ceteris Paribus

One of the main criticisms of ceteris paribus is that it takes assumptions too far, thereby forgetting the human element of economics. More often than not, these assumptions create highly unrealistic if not impossible models. For example, the models of perfect competition, marginal utility, and elasticity of demand are all based upon certain assumptions that do not occur in the real-world.

The criticism of ceteris paribus is not without merit. For example, supply and demand is at the heart of economics. As demand goes up, prices increase. As prices increase, supply also increases as suppliers aim to take advantage of price rises. However, there are a large number of factors which are not considered and therefore, the model may not represent the real-world.

Looking at supply and demand, there is the assumption that suppliers will in fact increase supply. Yet in the real-world, suppliers may not want to in order to maintain high profit margins. Alternatively, they may not be able to, which is one of the factors which is driving up prices. As we have seen during the period of COVID, many supply chains become disrupted, with suppliers unable to meet higher demand even if they wanted to.

FAQs

What is ceteris paribus in economics?

Ceteris Paribus is a phrase used in economics that makes economic analysis simpler. In essence, Ceteris Paribus means other things equal’. With regards to economics, it assumes that other influencing factors are held constant.

What is an example of ceteris paribus?

If the price of Coca-Cola falls, ceteris paribus, its demand will increase. Ceteris paribus means that other factors are not considered, or are considered to remain constant. Pepsi may react and reduce their prices as well, which may mean demand remains unchanged.

Why is ceteris paribus important?