Definition of ceteris paribus
Ceteris paribus is a Latin phrase meaning ‘all other things remaining equal’
The concept of ceteris paribus is important in economics because in the real world it is usually hard to isolate all the different variables.
Assuming ceteris paribus allows us to simplify economics – we can understand how something like higher price will affect – demand – ignoring all other factors which might complicate the outcome.
Example of Ceteris Paribus in Economics
- An increase in interest rates will ‘ceteris paribus’ cause the demand for loans to fall. (Higher interest rates increase the cost of borrowing so there will be less demand for loans. However, if confidence was high, people might still want to borrow more. Ceteris paribus assumes things like confidence remain the same.)
- Ceteris paribus – higher oil prices should lead to less demand for oil.
- Ceteris paribus – higher interest rates should lead to lower economic growth.
- Ceteris paribus – higher prices of coffee should encourage growers to try and increase the supply of coffee.
Importance of ceteris paribus
In the real world, it is very hard to isolate only one factor. For example, if we look at exchange rates, we would expect higher interest rates (ceteris paribus) to cause an appreciation in the currency.
But, in the real world, there will be many other factors affecting exchange rates. For example, if there was a lack of confidence in the countries economy, then investors may not want to buy the currency – despite higher interest rates.
However, by isolating the other factors, we can consider how higher interest rates are likely to have an effect and understand the impact of higher interest rates – ignoring all the other complicating factors.