Meaning of Ceteris Paribus In economics and finance

In economics and finance, the term is used as shorthand for indicating the effect of one economic variable on another, holding constant all other variables that may affect the second variable One of the disciplines in which ceteris paribus clauses are most widely used is economics, in which they are employed to simplify the formulation and description of economic outcomes.

When using ceteris paribus in economics, assume all other variables except those under immediate consideration are held constant, . In effect all extra variables remain unchanged and there are no outside influences on the variables being looked at. The only variables being considered are price and demand. It does not take into account any other things, such as inflation, product improvements, etc. This allows for the explanation, examination and understanding of basic economic rules.

This operational description intentionally ignores both known and unknown factors that may also influence the relationship between price and quantity demanded, and thus to assume ceteris paribus is to assume away any interference with the given example. Such factors that would be intentionally ignored include: the relative change in price of substitute goods, (e. g. , the price of beef vs pork or lamb); the level of risk aversion among buyers (e. g. , fear of mad cow disease); and the level of overall demand for a good regardless of its current price level (e. g. a societal shift toward vegetarianism) In this example, the clause is used to operationally describe everything surrounding the relationship between both the price and the quantity demanded of an ordinary good. when discussing the laws of supply and demand, one could say that if demand for a given product outweighs supply, ceteris paribus, prices will rise. Here, the use of “ceteris paribus” is simply saying that as long as all other factors that could affect the outcome (such as the existence of a substitute product) remain constant, prices will increase in this situation.

For example as the price of Pepsi cola rises, the quantity demanded of Pepsi cola falls, ceteris paribus. If the price raise of Pepsi-cola and nothing else changes, in other words, people’s preferences stay the same, the recipe for Pepsi-cola stays the same, and so on, then in response to the higher price of Pepsi-cola, people will buy less Pepsi-cola. In a nutshell the term ceteris paribus is used to define the law of demand and supply and it literally means all other things remain constant and nothing else changes.