Two Little Words That Simplify Economics
Ceteris paribus is a Latin phrase that means "all other things being equal." Experts use it to explain the theory behind laws of economics and nature. It means that most of the time, something will occur as a result of something else. That is, of course, if nothing else changes.
For example, the law of gravity states that a bathroom scale thrown out the window will fall to the ground, ceteris paribus. Gravity will send the bathroom scale plummeting to the ground as long as nothing else changes.
What if a micro-burst kept it hovering in the air? That powerful gust of wind is an example of all other things not being equal. The law of gravity is still valid even though, this time, the bathroom scale didn't fall to the ground.
Use in Economics
The concept and phrase of ceteris paribus are used extensively in economics. That's because there are so many variables constantly changing. The law of gravity is easy to understand because it's rare for something else to intervene. The bathroom scale will almost always fall to the ground.
That's not the case in economics. Everything is always changing. That makes it harder to create economic laws than physical laws. That's where ceteris paribus makes economics simple. It allows you to imagine a situation where only two variables change. You can focus on how a change in the independent variable affects the dependent variable.
The law of demand states, "If demand drops - ceteris paribus - then prices will fall to meet demand." It lets you know that the only two variables under discussion are price and demand. If demand drops, all other things being equal, prices will too.
In other words, when people want less of a good or service, then sellers will lower the prices. They could cut back on manufacturing to lower supply and keep prices the same. Or they could update the product to stimulate demand. That's what Apple does to maintain high prices. Sometimes manufacturers can't lower the price because their costs are too high. In that case, they'll accept a lower volume.
In the real world, all other things are never equal. But using the concept of ceteris paribus allows you to understand the theoretical relationship between cause and effect.
The economic law of demand is like the physical law of gravity. When you throw the bathroom scale out the window, and it comes right back at you, you don't assume the law of gravity was suspended. You look for what else has changed. Similarly, if demand drops and prices go up, the law of demand is still operable. But you now know to look for the other things that are no longer equal.
Here's a real-world example. Thanks to the Great Recession, demand for oil dropped. It declined from 86.66 million barrels per day in the fourth quarter 2007 to 85.73 million barrels per day in the first quarter of 2008. The law of demand says that oil prices should drop to meet demand. Instead, prices increased from $87.79 a barrel to $110.21 a barrel during that same period.
Thanks to your understanding of ceteris paribus, you would now look to find out what other things were unequal. You would have found that commodities traders, afraid to enter the stock market, were now trying to gain profit by bidding up the price of oil. There was an influx of money into commodities markets. The greater demand for oil futures is a large factor in what makes oil prices so high.
Ceteris paribus pronounced like "se-ter-es pa-re-bes." If that doesn't help, just think of it like you're saying this sentence fast: "Setter is pear a bus."
The Bottom Line
To explain economic behavior, economists may opt to simplify the economic mechanism. Two or three variables are isolated, while all others are assumed as constant, unchanging, or in the state of ceteris paribus. This facilitates the study of causative effects among the segregated variables. Although the ceteris paribus methodology cannot predict absolutes or certainties, it offers base knowledge of tendencies or probabilities.