Ceteris Paribus Meaning Applications Assumptions Example

Ceteris Paribus Meaning

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Ceteris paribus helps most economists study one relationship mechanism and its corresponding cause between two variables. As a result, experts use it to explain many economic concepts easily. Moreover, it also helps analyze many economic situations in the real world via exaggerated assumptions.

Explained

Ceteris Paribus or Caeteris Paribus is a Latin phrase that means ‘other conditions being constant’ or ‘all else being equal’. It helps in understanding the cause-and-effect relationship between two variables. In economics discussions, Juan de Medina and Luis de Molina first used it in the sixteenth century. It is the most widely used and dominant concept in economics and finance for analysis of economic theory. It cannot predict anything with certainty or absoluteness. However, it provides a base for the possible way to determine causal relations.

Key Takeaways

Ceteris Paribus means that only the cause-and-effect relationship between two variables will be deduced when other external factors remain unchanged.It helps to simplify the mechanism of economics and finance and allows easy explanation of economic theories.It is based on the assumption that other related variables remain the same during the study of the effect of one economic variable on another.Its limitation is that it is challenging to hold all other economic variables constant to isolate the dependent variable to study economic models.

Simply put, it assumes that two variables have a cause-and-effect relationship only when the external factors, which might affect the variables, remain the same. In economics, all the variables are constantly changing; this concept helps to understand any economic or financial mechanisms. Economists and financial analysts find it difficult to factor in all the dynamic variables together simultaneously and then study the variables’ relationship. Studying such relationships leads to chaos and complexity in the calculations. Moreover, this concept points out some important factors. Example includes price, that directly impacts the connection between two variables like supply and demand.

The price factor can associate multiple variables responsible for the change in demand for a commodity. Likewise, supply always increases when the demand for a product rise, provided other things like input cost, wages, and taxes remain the same. Thus, ceteris paribus comes into play, and one can say that supply falls whenever demand falls.

Application Of Ceteris Paribus

It simplifies economics by helping economists to study and test economic models. It forms a solid base to make economic theories stand the test of time. Once theorists use it to form a base, they keep other factors aside. They then study the connection between two variables without interruption. For example, other things remaining constant, lower interest rates would lead to higher economic growth.

Another ceteris paribus example includes the law of supply. According to economists, the law of supply demonstrates that all this remaining constant, producers supply more goods when at higher prices. If the product supply exceeds the demand, prices will likely fall only if other factors remain unchanged. So, the law of demand and supply will apply only when other variables like cost, raw material, labor supply, and inflation remain constant; otherwise, it may not be applicable. For example, other things remaining unchanged, higher diesel prices would lead to less demand for diesel.

Hence, it is a method of scientific modeling that includes identifying, isolating, and studying the impact of one variable on the other.

Assumptions Of Ceteris Paribus

Here are some prime ceteris paribus assumptions:

It is based on the assumption that all other conditions and variables that might affect the relationship between two independent variables will remain constant while studying their relationship. However, it is significant in real life as the external situation always keeps changing, affecting the study of the relationship between two independent variables.If economists do not isolate the two economic variables, they might be unable to explain the relationship between them. For example, price is a dependent variable, and demand is an independent variable whose relationship must be determined. Moreover, external factors like raw materials or labor availability may change abruptly in the real world, exponentially affecting the relationship between price and demand.

Therefore, to understand the relationship between price increase and demand, all the other factors must be equal or constant. As a result, the assumption of ceteris paribus becomes significant in such situations. These assumptions help to transform an otherwise dismal science or soft social science into a positive hard science like physics and chemistry.

Example

Here is a ceteris paribus example to understand the concept better.

When the price of a certain mobile phone, for example, iPhone manufactured by Apple Inc., decreases, it is assumed that its demand will increase more in the market. So, if a customer goes to an Apple store and finds that iPhones have 50% off on their base price, then one may buy more than one iPhone.

However, the above ceteris paribus assumption does not consider whether everyone can afford iPhones even at a lower price, whether everyone likes iPhones, and whether everyone has the actual need for a new iPhone in their lives.

In the same way, economists predict that if the price of pizza increases, other variables remain constant, and buyers will demand a lesser quantity of pizza. Here, if we consider some unknown factors like if the buyers like to consume pizza and if it gives them a high utility, then they will not give up on the consumption even if prices increase.

Thus, ceteris paribus is a simple tool to assess the relation between demand and supply, but only when other factors remain constant.

Limitations Of Ceteris Paribus

While studying the market in reality –

In an economy, economists can never assume or keep ‘all other factors constant.They cannot control all the variables to test them.They cannot identify all the significant or potential variables.

It has its limitations; however, it is a significant concept to study relative tendencies in the market.