What is Cataris Paribus?
Ceteris paribus, literally “taking other things constant”, is a Latin phrase usually translated into English as “all things being equal.” The dominant assumption in mainstream economic thought, it acts as a brief indication of the effect of one economic variable on another, provided all other variables remain the same.
In economics and finance, ceteris paribus is often used when arguing about cause and effect. An economist might say raising the minimum wage increases unemployment, increasing the money supply causes inflation, reducing marginal costs increases economic profits for a firm, or enacting rent control laws in a city causes the available housing supply to decrease.
Ceteris paribus assumptions help turn deductive social science into methodologically positive “hard” science. It creates an imaginary system of rules and conditions from which economists can pursue certain goals. Take another path; it helps economists avoid human nature and the problem of limited knowledge.
Most, if not all, economists rely on ceteris paribus to build and test economic models. In plain language, that means economists can hold all the variables in the model constant and tinker with them one by one. Ceteris paribus has its limitations, especially when such arguments overlap. Nevertheless, it is an important and useful way of describing relative trends in the market.
Suppose someone wants to explain the price of milk. With a little thought, it turns out that the cost of milk is affected by many things: the availability of cows, their health, the cost of feeding the cows, the amount of useful land, the cost of possible milk substitutes, the number of milk suppliers, the rate of economic inflation, consumer preferences, transportation, and many other variables. other. So an economist instead applies ceteris paribus, which is basically saying if all other factors are held constant, a decrease in the supply of milk-producing cows causes the price of milk to rise.
As another example, take the law of supply and demand. Economists say the law of demand shows that ceteris paribus (all things being equal), more of a good tends to be bought at a lower price. Or, if the demand for a product exceeds the supply of the product, ceteris paribus, the price is likely to rise.
Ceteris paribus is an extension of scientific modeling. The scientific method is built to identify, isolate, and test the impact of the independent variable on the dependent variable. Since economic variables can only be isolated in theory and not in practice, ceteris paribus can only highlight trends, not absolutes.
Two major publications helped move mainstream economics from a deductive social science based on logical observation and deduction to an empirical positivist natural science. The first was L’on Walras’ Elements of Pure Economics in 1874, which introduced the general equilibrium theory. The second was John Maynard Keynes, The General Theory of Employment, Interest, and Money in 1936, who created modern macroeconomics.
Cateris Paribus in Economics
In an attempt to become more like the academically respected “hard science” of physics and chemistry, economics became math-intensive. Variable uncertainty, however, is a major problem; Economics cannot isolate controlled and independent variables for mathematical equations. There are also problems with applying the scientific method, which isolates certain variables and tests their relationships to prove or disprove a hypothesis. Economics is not naturally suited to the testing of scientific hypotheses. In the field of epistemology, scientists can learn through logical thought experiments, also known as deduction, or through empirical observation and testing, also known as positivism. Geometry is a logical 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, keep all their actions constant, and then run special tests. No economist can even identify all the important variables in a given economy. For a given economic event, there may be dozens or hundreds of potential independent variables.
Mainstream economists build abstract models in which they pretend all variables are held constant, except those they want to test. This pretense, called ceteris paribus, is at the heart of general equilibrium theory. As economist Milton Friedman wrote in 1953, “a theory must be judged on its predictive power for the class of phenomena it purports to ‘explain’.” By imagining all but one variable held constant, economists can turn a relative deductive market trend into an absolutely controllable mathematical progression. Human nature is replaced by a balanced equation.
Suppose an economist wants to prove that the minimum wage causes unemployment or that easy money causes inflation. He could not have founded two identical test economies and introduced minimum wage laws or started printing dollars.
So the positive economist, tasked with testing his theory, must create a suitable framework for the scientific method, even if this means making very unrealistic assumptions. Economists assume buyers and sellers are price takers rather than price makers. Economists also assume that actors are perfectly informed about their choices, because any doubt or wrong decision based on incomplete information creates gaps in the model.
If the model generated in ceteris paribus economics appears to make accurate predictions in the real world, the model is considered successful. If the model does not appear to be making accurate predictions, the model will be revised.
This can complicate positive economics; Circumstances may exist that make one model look right one day but wrong a year later. Some economists reject positivism and embrace deduction as the primary mechanism of discovery. The majority, however, accepted the limitations of the ceteris paribus assumption, to make economics more like chemistry and less like philosophy.
The Ceteris paribus assumption is at the core of almost all mainstream microeconomic and macroeconomic models. Even so, some critics of mainstream economics point out that ceteris paribus gives economists a reason to get past the real problems of human nature. Economists admit that this assumption is highly unrealistic, but this model leads to concepts such as the utility curve, cross elasticity, and monopoly. Antitrust laws are actually based on the perfect competition argument. The Austrian school of economics believed that the ceteris paribus assumption had been taken too far, turning economics from a logical and useful social science into a series of mathematical problems.
Let’s return to the example of supply and demand, one of the favorite uses of ceteris paribus. Every introductory textbook on microeconomics, most notably Samuelson (1948) and Mankiw (2012), shows a static supply and demand graph in which prices are assigned to 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 that economists can remove difficulties in the price discovery process.
But price is not a separate entity in the real world of producers and consumers. Instead, consumers and producers themselves determine prices based on how much they subjectively value the good versus the amount of money traded. In 2002, financial consultant Frank Shostak wrote that this supply-demand framework was “despite the fact of reality.” Rather than solving an equilibrium situation, he argues, students should learn how prices emerge in the first place. He claims that subsequent conclusions or public policies derived from these abstract graphic representations are always flawed.
Like prices, many other factors that affect the economy or finances are constantly changing. Independent studies or tests allow the use of the ceteris paribus principle. But in reality, with something like the stock market, one can never assume “everything else is equal.” There are too many factors that affect stock prices that can and do change constantly.
