Economics Terms A-Z
When economists say “ceteris paribus” they are talking about the direct effect of X on Y while assuming that the rest of the world stands still. Ceteris is Latin for “other things” and paribus means “equal” so the literal translation is “other things being equal” but in economics it is generally understood to mean that all other things remain equal or constant (while dealing with the issue at hand).
For example, one may wonder what the impact of introducing a minimum wage will be on the level of employment in an economy. A basic economic analysis of the labour market, as shown in the graph just below, might simply consider employers’ demand for labour D and (potential) employees’ supply of it S, quantified in hours worked per period for a particular hourly rate of pay. Demand for labour increases as the hourly wage falls since it becomes cheaper to hire workers. On the other hand, the supply of labour increases as the hourly wage rises because it is more attractive for people to work at higher wages. In this free labour market, equilibrium is where demand meets supply and h* hours are purchased by employers at the hourly wage of w* (the market-clearing rate of pay).
All else equal, ceteris paribus, if a minimum wage Wm is introduced that is higher than the market-clearing rate of pay w* then employers will demand less labour and there will be a reduction in employment (total hours worked decrease from h* to hm), creating involuntary unemployment: although there are workers in the labour market who would like to supply more hours’ work than hm at the minimum wage Wm employers are unwilling to pay for more than hm hours at the new rate.
Note how this basic analysis ignores other effects of the increase in wages, such as what happens to the workers who remain in employment. They now earn more per hour and may spend their extra earnings, increasing their demand for goods and services, which could end up creating more employment than the graph suggests. The workforce could also become more productive if employers choose to shed less productive employees first. This would normally make the economy more competitive with other economies, leading to greater exports. In turn, (domestic) employers will again increase their demand for labour.
The above example of ceteris-paribus analysis with its conclusion that “a minimum wage creates unemployment” also ignores the effects of other things that are potentially happening simultaneously. The supply of labour might be growing or shrinking due to demographic changes, or the effects of a new income-tax or child-benefit policy introduced at the same time. A more realistic economic model might attempt to incorporate some of these complexities.
A ceteris-paribus approach thus typically involves partial-equilibrium rather than general-equilibrium analysis and focuses on the short term rather than the medium or longer term. While this may not seem satisfactory from a practitioner perspective, there is an advantage to simplifying the world through ceteris-paribus modelling: it allows the analyst to concentrate on one mechanism at a time and to try to understand and explain causal relationships. As long as the economic analyst is careful not to overstate claims, a ceteris-paribus analysis often offers more insight than do ambitious attempts to explain everything that is happening at once throughout the whole economy.
The philosopher and economist Daniel Hausman provides a critical account of deductivism in economics and how ceteris paribus has been (mis)used by economists over the years in “Economic Methodology in a Nutshell” (Journal of Economic Perspectives, 1989).
Good to know
Although the real world is generally too messy to test economic theories that rely on ceteris-paribus assumptions, there are ways to get around this. Behavioural economists design experiments that essentially create ceteris paribus within a controlled laboratory setting. Participants in the experiments are asked to make decisions under certain conditions. The experimenter is then able to isolate the direct effects of policy changes by altering one condition at a time while holding all else equal: ceteris paribus!
Consumer Surplus and Producer Surplus
Consumer surplus is the gain made by consumers when they purchase an item at the competitive market price rather than the (highest) price that they would have been willing to pay for it. Analogously, producer surplus is the gain made by producers when they sell an item at the market price rather than the (lowest) price that they would also have accepted for it.
Factor markets (or resource markets) are markets for the inputs to production. A producer is typically a seller in the market for a product (supply SG in the graph below) while simultaneously being a buyer in the markets for its factors of production (demand DF below).
Marginal revenue (MR) measures the change in total revenue that occurs when a firm increases output by one unit, i.e., it is the extra income (or revenue) generated by selling one additional unit.