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Explain why the assumption of 'ceteris paribus' is important in economic analysis. Use an example in your answer.

Question

Explain why the assumption of 'ceteris paribus' is important in economic analysis. Use an example in your answer.

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Solution

The term 'ceteris paribus' is a Latin phrase that translates to 'all other things being equal.' This assumption is crucial in economic analysis for several reasons:

  1. Simplification: Economics often deals with complex systems where multiple variables can change simultaneously. The ceteris paribus assumption allows economists to simplify these systems by focusing on the relationship between two variables while assuming that all other variables remain constant. This makes it easier to understand the cause and effect relationship between these two variables.

  2. Isolation of effects: By holding all other variables constant, economists can isolate the effect of one variable on another. This helps in understanding the individual impact of each variable.

  3. Theoretical analysis: The ceteris paribus assumption is also important for theoretical analysis. It allows economists to build theories and models by assuming a simple world where all variables except those under consideration are constant.

For example, let's consider the law of demand, which states that as the price of a good increases, the quantity demanded decreases, ceteris paribus. Here, the ceteris paribus assumption implies that factors like consumer income, tastes and preferences, prices of related goods, etc., are held constant while examining the relationship between the price of the good and its quantity demanded. Without this assumption, it would be difficult to establish a clear relationship between price and quantity demanded as changes in these other factors could also affect the quantity demanded.

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