Ceteris Paribus

Loading the player...

What is 'Ceteris Paribus'

The Latin phrase ceteris paribus – literally, “holding other things constant” – is commonly translated as “all else being equal.” A dominant assumption in mainstream economic thinking, it acts as a shorthand indication of the effect of one economic variable on another, provided all other variables remain the same. In the fields of economics and finance, the phrase and concept is often used when making arguments about cause and effect.

An economist might say, ceteris paribus, raising the minimum wage increases unemployment; increasing the supply of money causes inflation; reducing marginal costs boosts economic profits for a firm; or establishing rent control laws in a city causes the supply of available housing to decrease.

Most, though not all, economists rely on ceteris paribus to build and test economic models. In simple language, it means the economist can hold all variables in the model constant and tinker with them one at a time. Ceteris paribus has its limitations, especially when such arguments are layered on top of one another. Nevertheless, it is an important and useful way to describe relative tendencies in markets.

BREAKING DOWN 'Ceteris Paribus'

Ceteris paribus assumptions help transform an otherwise deductive social science into a methodologically positive "hard" science. It creates an imaginary system of rules and conditions from which economists can pursue a specific end. Put another way, it helps the economist circumvent human nature and the problems of limited knowledge.

Suppose you wanted to explain the price of milk. With a little thought, it becomes apparent that milk costs are influenced by numerous things: the availability of cows, their health, the costs of feeding cows, the amount of useful land, the costs of possible milk substitutes, the number of milk suppliers, the level of inflation in the economy, consumer preferences, transportation and many other variables. So an economist instead applies ceteris paribus, which essentially says if all other factors remain constant, a reduction in the supply of milk-producing cows causes the price of milk to rise.

As another example, take the laws of supply and demand. Economists say the law of demand demonstrates that, ceteris paribus (all else being equal), more goods tend to be purchased at lower prices. Or that, if demand for any given product exceeds the product’s supply, ceteris paribus, prices will likely rise.The complicated nature of economics makes it difficult to account for all of the possible variables that determine supply and demand, so ceteris paribus assumptions simplify the equation so that the causal change can be isolated.

Ceteris paribus is an extension of scientific modeling. The scientific method is built on identifying, isolating and testing the impact of an independent variable on a dependent variable. Since economic variables can only be isolated in theory and not in practice, ceteris paribus can only ever highlight tendencies, not absolutes.

How Ceteris Paribus Developed

Economic principles begin as logical observations and deductions: Resources are scarce; individuals prefer a present good to a future good; economic decisions are made on the margin; marginal utility tends to decline with each successive good; value is derived subjectively. However, two major publications helped move mainstream economics from a deductive social science into an empirically positivist natural science. The first was Leon Walras' "Elements of Pure Economics" in 1874, which introduced general equilibrium theory. The second was John Maynard Keynes' "The General Theory of Employment, Interest and Money" in 1936, which created modern macroeconomics.

In an attempt to be more like the more academically respectable "hard sciences" of physics and chemistry, economics became math-intensive. Variable uncertainty was a major problem, though; economics could not isolate controlled and independent variables for math equations. There was also a problem with applying the scientific method, which isolates specific variables and tests their interrelatedness to prove or disprove a hypothesis. Economics does not naturally lend itself to scientific hypothesis testing. In the field of epistemology, scientists can learn through logical thought experiments, also called deduction, or through empirical observation and testing, also called positivism. Geometry is a logically deductive science. Physics is an empirically positive science.

Unfortunately, economics and the scientific method are naturally incompatible. No economist has the power to control all economic actors, hold all of their actions constant and then run specific tests. In fact, no economist can even identify all of the critical variables in a given economy. For any given economic event, there could be dozens or hundreds of potential independent variables.

Enter ceteris paribus. Mainstream economists construct abstract models where they pretend all variables are held constant, except the one they want to test. This style of pretending, called ceteris paribus, is the crux of general equilibrium theory. As economist Milton Friedman wrote in 1953, "theory is to be judged by its predictive power for the class of phenomena which it is intended to 'explain.' " By simply imagining all variables save one, are held constant, economists can transform relative deductive market tendencies into absolute controllable mathematical progressions. Human nature is replaced with balanced equations.

 Benefits of Using Ceteris Paribus in Economics

Suppose an economist wants to prove a minimum wage causes unemployment or that easy money causes inflation. He could not possibly set up two identical test economies and introduce a minimum wage law or start printing dollar bills.

So the positive economist, charged with testing his theories, must create a suitable framework for the scientific method, even if this means making very unrealistic assumptions. The economist assumes buyers and sellers are "price-takers" rather than price makers. The economist also assumes actors have perfect information about their choices, since any indecision or incorrect decision based on incomplete information creates a loophole in the model.

If the models produced in ceteris paribus economics appear to make accurate predictions in the real world, the model is considered successful. If the models do not appear to make accurate predictions, they are revised. This can make positive economics tricky; circumstances might exist that make one model look correct one day but incorrect a year later. There are some economists who reject positivism and embrace deduction as the principle mechanism of discovery. The majority, however, accept the limits of ceteris paribus assumptions, to make the field of economics more like chemistry and less like philosophy.

Arguments Against Using Ceteris Paribus in Economics

Ceteris paribus assumptions are at the heart of nearly all mainstream microeconomic and macroeconomic models. Even so, some critics of mainstream economics point out that ceteris paribus gives economists the excuse to bypass real problems about human nature. Economists admit these assumptions are highly unrealistic, and yet these models lead to concepts such as utility curves, cross elasticity and monopoly. Antitrust legislation is actually predicated on perfect competition arguments. The Austrian school of economics believes ceteris paribus assumptions have been taken too far, transforming economics from a useful, logical social science into a series of math problems.

Let's go back to the example of supply and demand, one of the favorite uses of ceteris paribus. Every introductory textbook into microeconomics, notably Samuelson (1948) and Mankiw (2012), show static supply and demand charts where prices are simply given to both producers and consumers; that is, at a given price, consumers demand and producers supply a certain amount. This is a necessary step, at least in this framework, so economics can assume away the difficulties in the price-discovery process.

But prices are not a separate entity in the real world of producers and consumers. Rather, consumers and producers themselves determine prices based on how much they subjectively value the good in question versus the quantity of money for which it is traded. In 2002, financial consultant Frank Shostak wrote that this supply-demand framework is "detached from the facts of reality." Rather than solving equilibrium situations, he argued, students should learn how prices emerge in the first place. He claimed any subsequent conclusions or public policies derived from these abstract graphical representations are necessarily flawed.

Like prices, many other factors that affect the economy or finance are continuously in flux. Independent studies or tests may allow for the use of the ceteris paribus principle. But in reality, with something like the stock market, one cannot ever assume "all other things being equal." There are too many factors affecting stock prices that can and do change constantly; you can't isolate just one.

Ceteris Paribus v. Mutatis Mutandis

While somewhat similar in assumption aspects, ceteris paribus is not to be confused with mutatis mutandis, translated as “once necessary changes have been made.” It is used to acknowledge that a comparison, like the comparison of two variables, requires certain necessary alterations that are left unsaid because of their obviousness. In contrast, ceteris paribus excludes any and all changes except for those that are explicitly spelled out. More specifically, the phrase mutatis mutandis is largely encountered when talking about counterfactuals, used as a shorthand to indicate initial and derived changes that have been previously discussed or are assumed to be obvious.

The ultimate difference between these two contrasting principles boils down to correlation versus causation. The principle of ceteris paribus facilitates the study of the causal effect of one variable on another. Conversely, the principle of mutatis mutandis facilitates an analysis of the correlation between the effect of one variable on another, while other variables change at will.