Ceteris paribus makes it easy for us to analyze and draw conclusions. Of course, we should consider all critical variables when analyzing something. But, applying all variables into the analysis is time-consuming. It is also difficult to control the effect of each variable.
Definition of ceteris paribus
Ceteris paribus comes from the Latin, meaning “other things being equal.” It is a crucial assumption and underpins various economic models. We use it in analysis to determine the effect of the variable we are examining.
When we try to understand the relationship between two or more variables, we often assume that everything else, other than the variables we study, does not change.
It is difficult for us to conclude if we include all the variables. Thousands of variables present in the real world, and to control each of these variables is impossible.
Why you should use it
By assuming ceteris paribus, we isolate the effects of other factors beyond what we are studying. This assumption does not say anything about what happens in the real world. It is just a tool that we use to build hypotheses or models, making it easier to analyze and conclude.
Now let’s take a simple example of rice demand. Say, we only use price to explain the change in quantity demanded.
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Of course, using only the price, it is unrealistic in the real world. Other variables also determine rice demand, such as population growth and population income.
Incorporating all of those variables into the analysis is difficult. Because if all of these variables change at the same time, we have no way of knowing the effect of each variable individually. Is it price, is it income or population.
So, we should isolate the effects of non-price factors. To test the hypothesis, we only look at the impact of the price. It means we are assuming non-price factors must be constant, or not change. When presenting the results of the analysis, we will say that we are examining the effect of rice prices on the quantity of rice demanded, ceteris paribus.
Another example is when looking at the effect of income tax cuts on consumption. Assuming other factors are constant, we expect that most people will spend more money on goods and services when their income rises.
But, if at the same time inflation soared and the central bank raised interest rates to curb inflation, people might not spend more money on goods and services. That is why it is essential to control other variables beyond what we are examining.