What It Means
Ceteris paribus is a Latin term that translates as “all other things being equal” or “holding all else constant.” When analyzing a particular aspect of the economy, it is often necessary to make the ceteris paribus assumption—that is, to hypothesize that all other things besides the factors under consideration will remain constant. Without making this assumption it would frequently be impossible to theorize about the effect of one factor on another.
For example, consider the relationship between demand (the quantity of a good that buyers are willing to buy over a range of prices) and the price of that good. We can predict what will happen when, say, the price of soda in vending machines on a college campus rises from $1 to $2—students will buy fewer cans of soda—but only if we assume that all other factors are constant. There are other factors that could affect demand for soda, such as an increase in student wealth, which may make the price increase have less impact on demand, or unseasonably warm weather, which may make students more likely to buy soda regardless of the price. In order to understand precisely what effect price and demand have on one another, however, we isolate these two factors from all others and temporarily act as though those other factors are, for the moment, constant.
The ceteris paribus assumption offers a way of simplifying reality in order to achieve greater understanding of the relationship under consideration. Once we possess this information (once we can say with confidence that rising prices result in decreased demand for soda), we have a foundation of more certain knowledge than we would have had if we tried to speculate about multiple inconstant factors at once.
When Did It Begin
The British economist Alfred Marshall (1842–1924) is responsible for making the notion of ceteris paribus a central part of economic theory. Marshall’s Principles of Economics (1890), the dominant English-language economics textbook for decades after its publication, synthesized the existing economic thought of his time and established a method of analysis that is still used today. That method, called partial equilibrium analysis, or comparative statics, was an answer to the difficulty of comprehending an entire, dynamic economy as a whole. Instead of attempting to account for the interrelation of all economic factors at all times, Marshall showed that economists could gain understanding of individual parts of the economy by temporarily isolating them from all other factors and making the ceteris paribus assumption. Partial equilibrium analysis remains an important analytical method among economists today.
More Detailed Information
Partial equilibrium analysis proposes that economists must necessarily simplify the economy in order to understand it. In a developed capitalist country such as the United States, no central authority controls the forces that shape the economy. Instead, hundreds of millions of individual buyers and sellers of goods and services make billions of individual decisions every day, usually with the intent of increasing their own economic well-being. These independent decisions collectively determine what goods and services are produced, how and in what quantities they are produced and distributed, and who benefits from this production and distribution. It is obviously impossible to monitor every individual economic factor or to account for all factors that might affect production and distribution. By isolating one changing economic factor at a time and assuming that all other factors are momentarily constant, however, economists can build simplified, hypothetical models of the economy. These individual models offer insights into specific parts of the economy, and we can assemble these specific parts into a reasonably accurate view of the overall picture.
A model can be a real economy that is simplified in a way that yields useful insights. For example, economists might study a prison economy in which all individuals, including those who do not smoke, use cigarettes as a form of money. Many factors that affect the national economy (for example, international trade, taxes, and the stock market) are not present in the prison economy, but this does not mean that the insights provided by the model are useless. Instead, an economist studying the prison economy would make the ceteris paribus assumption, acknowledging that, all else being constant, his or her theoretical findings hold true in the outside world no less than in the prison.
Basic economic concepts such as supply and demand are also models. When economists say that sellers are more willing to supply products as price increases, at the same time that buyers demand fewer products as price increases, they are offering a simplified picture of the economy in which all extraneous factors have been set aside (by making the ceteris paribus assumption).
The production possibility curve (PPC) is another such model. The PPC, rendered as a graph, is a tool for understanding the tradeoffs made when one good rather than another is produced. For example, an economist might construct a PPC showing how an increase in the production of chicken causes a corresponding decrease in the production of beef, and indicating what the optimal combinations of chicken and beef would be if the economy were operating at full efficiency. While it is true that there are many products other than chicken and beef, and that increases or decreases in the production of any product has wide-ranging effects that go beyond a single competing product, economists can assume ceteris paribus and study chicken and beef in isolation. This yields insights about the mechanics of economic tradeoffs that would not be forthcoming if we did not simplify.
It is important to understand that the ceteris paribus assumption is always temporary. Economists can build a model, study the effect of one factor on another by assuming ceteris paribus, and then relax the ceteris paribus assumption factor by factor. For example, in the case of the campus vending-machine economy, an economist might first speculate about the changes in demand caused by price, ceteris paribus, and then go on to observe how demand might be further changed by increases in student wealth and/or by unseasonable weather.
Most economic thought is a product of partial equilibrium analysis: the isolation of one economic factor or set of factors from all others using the ceteris paribus assumption, and the building of models that can be supported mathematically. Partial equilibrium and ceteris paribus remain central to the practice of economics, and they probably always will.
In the latter part of the twentieth century, however, a growing number of economists began to return to an approach pioneered in the late nineteenth century: general equilibrium analysis. Rather than isolating one factor from all others, general equilibrium analysis calls for monitoring the changes brought about in all factors when one factor changes. While partial equilibrium analysis requires the assumption that all other factors are constant, general equilibrium analysis attempts to account for the interconnection of all economic factors.
This is a more demanding approach to economic theory than partial equilibrium analysis. Until the 1970s, in fact, general equilibrium analysis was entirely theoretical. Economists could speculate about how changes in one economic factor might send ripples through the economy, but these ripple effects were too complex to lend themselves to the construction of useful models. With the advent of high-powered computers, however, mathematical modeling of entire national economies became possible.
"Ceteris Paribus." Everyday Finance: Economics, Personal Money Management, and Entrepreneurship. . Encyclopedia.com. (September 18, 2018). http://www.encyclopedia.com/finance/encyclopedias-almanacs-transcripts-and-maps/ceteris-paribus
"Ceteris Paribus." Everyday Finance: Economics, Personal Money Management, and Entrepreneurship. . Retrieved September 18, 2018 from Encyclopedia.com: http://www.encyclopedia.com/finance/encyclopedias-almanacs-transcripts-and-maps/ceteris-paribus