ceteris paribus

"Ceteris paribus" is a Latin phrase that is generally translated as "all other things being equal" or "with all other factors or things remaining the same." This is a common (frequently unstated) assumption of economic analysis used to isolate the effect of a particular event or phenomenon.

If an economist asks "What is the likely effect on the oil market of the discovery of new oil reserves in the Gulf of Mexico?" the ceteris paribus assumption ignores other events occurring at the same time that may also affect the market. For example, the emergence of a larger middle class in China is increasing car ownership and the demand for fuel. The market for oil may be affected by many forces of supply and demand at the same time. The ceteris paribus assumption allows analysts to isolate individual market forces from what are otherwise extremely complex interactions. To do a complete analysis of a market, however, one should consider all factors.

Supply & Demand - Questions for Further Study

1. Using supply & demand. Use supply and demand analysis to illustrate the likely effects of a hurricane in Florida on the equilibrium price and quantity in each of the following markets.

a. the market for orange juice. (Hint: The oranges grown in Florida are primarily used to make orange juice.)
b. the market for plywood. (Hint: Plywood is used to protect windows from the high winds associated with hurricanes.)
c. the market for batteries. (Hint: Hurricanes frequently know down power line, causing many people to be without electricity for days or weeks.)
d. the market for admission tickets to theme parks in Orlando. (Hint: Assume the hurricane causes heavy rain and wind throughout the Orlando area. Most of the attractions at these parks are outdoors.)
e. tickets for airline travel from Florida during the few days before the hurricane makes landfall. (Hint: Voluntary and mandatory evacuations are common when hurricanes threaten coastal areas.)

2. When supply and demand curves shift, there is a change in the equilibrium price and quantity. What is the relationship between the slope of the curves and the size of the changes in price and quantity?

3. Economists define the price elasticity of demand as the percentage change in the quantity demanded divided by the percentage change in the price of the product. How is elasticity useful in supply and demand analysis?

4. What happens to the equilibrium price and quantity when there is an increase in supply and demand? Does the answer depend on the magnitudes of the shifts?

5. What happens to the equilibrium price and quantity when there is a decrease in supply and demand? Does the answer depend on the magnitudes of the shifts?

6. What happens to the equilibrium price and quantity when there is an increase in supply and a decrease in demand? Does the answer depend on the magnitudes of the shifts?

7. What happens to the equilibrium price and quantity when there is a decrease in supply and an increase in demand? Does the answer depend on the magnitudes of the shifts?

8. Another example of a price control is a law that sets a minimum price that may be legally charged for an agricultural product, such as milk. Is this farm price control a price ceiling or a price floor? Draw a supply and demand diagram to illustrate the market price, equilibrium price, quantity supplied, quantity demanded, and the surplus or shortage when there is a binding farm price support. What is the social objective of a farm price support? What other methods could be used to achieve this objective? Would they be better than farm price supports?

Rent Controls

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Rent Controls

Many cities in the United States and the rest of the world have rent controls. The primary motive for rent controls is to provide affordable housing for low-income people. Most economists argue that rent controls are a lousy way to achieve that objective.

In their strictest sense, rent controls prevent the owners of housing (typically apartments) from increasing the rent they charge. Rent controls are examples of the type of price controls known as price ceilings. The law does not allow the price to rise above the ceiling.



The rent-controlled price is necessarily below the market equilibrium price. (Otherwise, there would be no need for rent controls.) What does supply and demand analysis suggest about the effect of imposing rent controls?

Suppose that in the absence of price controls a particular type of apartment in New York City would rent for $2,000 per month. Suppose New York has price controls that do not permit the landlord to charge more than $1,500 per month. In equilibrium, the number of apartments supplied at $2,000 per month equals the number of apartments demanded at that price.

At the rent-controlled price, however, the number of apartments supplied is smaller than in equilibrium. (For example, some apartment building owners may decide to convert their buildings into condominiums or office space if they are not allowed to charge the market rent for apartments.) The number of apartments demanded at the rent-controlled price exceeds the number of apartments supplied. The rent controls cause a shortage of apartments.

How well do rent controls achieve the objective of providing affordable housing for low-income people? If someone is lucky enough to have a rent-controlled apartment, they benefit from the policy. In practice, however, many of the people with rent-controlled apartments have middle or high incomes. (The rents are controlled, but the apartments may be available to anyone.)

Interfering with markets by controlling prices can lead to strange results. For example, tenants who want to move might continue to lease the apartment and sublet it at the higher market rate. (Thus the landlord is not receiving full compensation for providing the apartment, and the one who sublets the apartment receives substantial income just for keeping the lease.) Landlords also respond to rent controls by foregoing normal maintenance on the buildings. Landlords also might charge tenants extra fees to try to skirt the price controls and receive something closer to the market rent. Because of the shortage of apartments, many people who want an apartment at the rent controlled price are unable to find one. FEWER apartments are available to be rented with rent controls than without rent controls. Is this what we had in mind when choosing to implement rent controls?

Alternatives to rent controls which might achieve the objective of providing affordable housing for low income people:

• Provide low-income people with more income.
• Provide vouchers that can be used to pay for housing.
• Provide subsidized housing for low-income people.

Price Ceilings

A price ceiling sets a maximum price that can be legally charged in a market. It is binding if the price ceiling is below the equilibrium price in the market. Rent controls are an example of a price ceiling.

See "Price as a Rationer."

Minimum Wage Laws

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The Minimum Wage

Should we have a minimum wage in the United States?

Most people who support minimum wage laws feel they are necessary to ensure that unskilled workers have enough income to provide for themselves and their families. This is a reasonable societal goal. However, most economists argue that minimum wage laws are a lousy way to achieve that goal. We can use supply and demand analysis to explain why.

Minimum wage laws are applicable in the market for unskilled workers. (Highly skilled workers, such as doctors and lawyers, do not work for minimum wage.) The forces of supply & demand exist in the market for unskilled workers. The price of unskilled workers is the hourly wage that they are paid. At the equilibrium wage, the number of unskilled workers desiring a job equals the number of jobs offered by employers. The concern in this market is that this equilibrium wage does not provide sufficient income for these workers. Minimum wage laws attempt to increase the income of unskilled workers by requiring employers to pay these workers a higher wage than they would in the absence of the law.

What does supply & demand analysis suggest will be the outcome of this policy?

A minimum wage is a type of price control referred to as a price floor. The law does not allow the price to drop beneath the floor. The minimum wage is necessarily above the equilibrium wage. (If it were not, there would be no need for the minimum wage law.) At prices above equilibrium, however, the quantity of unskilled labor supplied (i.e., the number of people willing to work at that wage) exceeds the quantity of unskilled labor demanded (i.e., the number of unskilled jobs offered by employers). Thus, at prices above equilibrium, there is a surplus of unskilled labor. Some of the workers are unemployed (i.e., not working) or underemployed (i.e., not working as much as they would like).

Has the minimum wage accomplished our objective of providing unskilled workers with more income? The answer is "yes" and "no." The unskilled workers who have jobs are better off because they are earning a higher wage. Yet, some of the workers who would have been employed in the absence of the minimum wage law are unemployed with the minimum wage laws. Have we helped these unskilled workers by instituting a policy that provides incentives for employers to reduce the number of unskilled jobs?



Most economists oppose minimum wage laws. They oppose them because they are inefficient at achieving the stated objective. If you support the idea of providing unskilled workers with more income, there are alternatives to the minimum wage that probably are more efficient.


Alternatives to the Minimum Wage

• Give unskilled workers more income. (After all, the problem is that unskilled workers do not have enough income, right?)
• Give unskilled workers in-kind transfers (i.e., provide them with food, clothing, housing, medical care, etc.)
• Provide unskilled workers with education & training (so they can obtain skills). Economists generally like this option. The workers who obtain skills are more productive and consequently earn more income. Education & training also reduces the supply of unskilled workers. (They become skilled workers.) The supply curve for unskilled workers shifts left. Other things equal, the new equilibrium in the market for unskilled workers occurs at a higher wage. Education & training programs benefit the workers who receive the training (because they become more productive) and those workers who do not receive the training (because the supply of unskilled workers decreases). Wages for all of these workers increase. (Remember our goal is to increase the income of these workers.)

Price Floors

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Price Controls

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Economists use supply and demand analysis to examine most issues that affect the economy. For example, the supply & demand framework is used to examine minimum wage laws and rent controls.

Price controls are legal restrictions on the prices charged in the market for a product or resource.

A price floor is the minimum price that can be legally charged in a market. The minimum wage is an example of a price floor.

A price ceiling is the maximum price that can be legally charged in a market. Rent controls for apartments are an example of a price ceiling.

A Decrease in Supply & Demand

When supply and demand both decrease, the equilibrium quantity will decrease, but the equilibrium price may be unchanged, increase or decrease.

An decrease in supply is represented by a shift of the supply curve to the left.
An decrease in demand is represented by a shift of the demand curve to the left.

Ceteris paribus, in the new equilibrium:

Supply has decreased. (The supply curve shifted to the left.)
Demand has decreased. (The demand curve shifted to the left.)
The quantity supplied decreased to the new equilibrium quantity.
The quantity demanded decreased to the new equilibrium quantity.
The equilibrium price may increase, decrease, or stay the same depending on the magnitude of the shifts of supply and demand.

A decrease in supply typically causes an increase in the equilibrium price and a decrease in the equilibrium quantity.
A decrease in demand typically causes a decrease in the equilibrium price and a decrease in the equilibrium quantity.
Thus, the decreases in supply and demand are both contributing to the decrease in the equilibrium quantity. The decrease in supply is putting upward pressure on the equilibrium price. The decrease in demand is putting downward pressure on the equilibrium price. Since the supply shift and demand shift are trying to push the equilibrium price in opposite directions, the overall effect on the equilibrium price will depend on which effect is larger. The new equilibrium price could stay the same, increase or decrease:
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A Decrease in Supply & an Increase in Demand

Click on the illustration to enlarge it.

A decrease in supply is illustrated by a shift of the supply curve to the left.

A decrease in supply can be caused by:

• a decrease in the number of producers.
• an increase in the costs of production (such as higher prices for oil, labor, or other factors of production).
• weather (e.g., droughts, floods, or freezing temperatures decrease agricultural production)
• loss of technology (Technological innovations typically increase supply. If technology were to be lost, there could be a decrease in supply.)
• expectations (e.g., producers might decrease current production if they anticipate more favorable market conditions in the future.)

An increase in demand is illustrated by a shift of the demand curve to the right.

An increase in demand can be caused by:

• an increase in the number of consumers.
• an increase in income (for normal products) or a decrease in income (for inferior products, such as Ramen noodles).
• an increase in the price of a substitute product.
• a decrease in the price of a complementary product.
• a change in tastes and preferences (e.g., if the product has become more popular or fashionable)
• expectations (e.g., consumers might increase current demand if they anticipate less favorable market conditions, such as shortages or higher prices, in the future.)

When there is a decrease is supply and an increase in demand, the new equilibrium occurs at a higher market price. The new equilibrium quantity may be larger, smaller, or unchanged depending on the magnitudes of the shifts.

An Increase in Supply & a Decrease in Demand

Both curves shift in this case.

An increase in supply is illustrated by a shift of the supply curve to the right.

An increase in supply can be caused by:

• an increase in the number of producers.
• a decrease in the costs of production (such as lower prices for oil, labor, or other factors of production).
• weather (e.g., ideal conditions might increase agricultural production)
• technology (Technological innovations typically increase supply.)
• expectations (e.g., producers might increase current production if they anticipate less favorable market conditions in the future.)

A decrease in demand is illustrated by a shift of the demand curve to the left.

A decrease in demand can be caused by:

• a decrease in the number of consumers.
• an decrease in income (for normal products) or an increase in income (for inferior products, such as Ramen noodles).
• a decrease in the price of a substitute product.
• an increase in the price of a complementary product.
• a change in tastes and preferences (e.g., if the product has become less popular or fashionable)
• expectations (e.g., consumers might decrease current demand if they anticipate more favorable market conditions, such as lower prices, in the future.)

When there is an increase is supply and a decrease in demand, the new equilibrium occurs at a lower market price. The new equilibrium quantity may be larger, smaller, or unchanged depending on the magnitudes of the shifts.

When supply increases and demand decreases, ceteris paribus, in the new equilibrium:

Supply has increased. (The supply curve shifted to the right.)
Demand has decreased. (The demand curve shifted to the left.)
The quantity supplied (at the new equilibrium quantity) may increase, decrease, or be unchanged depending on the magnitude of the shifts of supply and demand.
The quantity demanded (at the new equilibrium quantity) may increase, decrease, or be unchanged depending on the magnitude of the shifts of supply and demand.
The equilibrium price has decreased.

An increase in supply typically causes a decrease in the equilibrium price and an increase in the equilibrium quantity.
An decrease in demand typically causes a decrease in the equilibrium price and a decrease in the equilibrium quantity.
Thus, the increase in supply and decrease in demand are both contributing to the decrease in the equilibrium price. The increase in supply is putting upward pressure on the equilibrium quantity. The decrease in demand is putting downward pressure on the equilibrium quantity. Since the supply shift and demand shift are trying to push the equilibrium quantity in opposite directions, the overall effect on the equilibrium quantity will depend on which effect is larger. The new equilibrium quantity could stay the same, increase or decrease:
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AN INCREASE IN SUPPLY & A DECREASE IN DEMAND WHERE QUANTITY IS UNCHANGED.

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AN INCREASE IN SUPPLY & A DECREASE IN DEMAND WHERE QUANTITY INCREASES.

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AN INCREASE IN SUPPLY & A DECREASE IN DEMAND WHERE QUANTITY DECREASES.

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An Increase in Supply & Demand

Both curves shift in this case.

An increase in supply is illustrated by a shift of the supply curve to the right.

An increase in supply can be caused by:

• an increase in the number of producers.
• a decrease in the costs of production (such as higher prices for oil, labor, or other factors of production).
• weather (e.g., ideal weather may increase agricultural production)
• technology (Technological innovations typically increase supply.)
• expectations (e.g., producers might increase current production if they anticipate less favorable market conditions in the future.)

An increase in demand is illustrated by a shift of the demand curve to the right.

An increase in demand can be caused by:

• an increase in the number of consumers.
• an increase in income (for normal products) or a decrease in income (for inferior products, such as Ramen noodles).
• an increase in the price of a substitute product.
• a decrease in the price of a complementary product.
• a change in tastes and preferences (e.g., if the product has become more popular or fashionable)
• expectations (e.g., consumers might increase current demand if they anticipate less favorable market conditions, such as shortages or higher prices, in the future.)

When there is an increase in supply and an increase in demand, the new equilibrium quantity increases. The new equilibrium price may be higher, lower, or unchanged depending on the magnitudes of the shifts.

When supply and demand both increase, ceteris paribus, in the new equilibrium:

Supply has increased. (The supply curve shifted to the right.)
Demand has increased. (The demand curve shifted to the right.)
The quantity supplied increased to the new equilibrium quantity.
The quantity demanded increased to the new equilibrium quantity.
The equilibrium price may increase, decrease, or stay the same depending on the magnitude of the shifts of supply and demand.

An increase in supply typically causes a decrease in the equilibrium price and an increase in the equilibrium quantity.
An increase in demand typically causes an increase in the equilibrium price and an increase in the equilibrium quantity.
Thus, the increases and supply and demand are both contributing to the increase in the equilibrium quantity. The increase in supply is putting downward pressure on the equilibrium price. The increase in demand is putting upward pressure on the equilibrium price. Since the supply shift and demand shift are trying to push the equilibrium price in opposite directions, the overall effect on the equilibrium price will depend on which effect is larger. The new equilibrium price could stay the same, increase or decrease:
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AN INCREASE IN SUPPLY & DEMAND WHERE PRICE IS UNCHANGED.


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AN INCREASE IN SUPPLY & DEMAND WHERE PRICE INCREASES


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AN INCREASE IN SUPPLY & DEMAND WHERE PRICE DECREASES

Shifts in Supply & Demand

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A Decrease in Supply

Click on the diagram above to enlarge it.

An decrease in supply is represented by a shift of the supply curve to the left.
Ceteris paribus, in the new equilibrium:

Supply has decreased. (The supply curve shifted to the left.)
Demand is unchanged. (The demand curve did not move.)
The quantity supplied decreased to the new equilibrium quantity.
The quantity demanded decreased to the new equilibrium quantity.
The equilibrium price increased.

An Increase in Supply

An increase in supply is represented by a shift of the supply curve to the right.
Ceteris paribus, in the new equilibrium:

Supply has increased. (The supply curve shifted to the right.)
Demand is unchanged. (The demand curve did not move.)
The quantity supplied increased to the new equilibrium quantity.
The quantity demanded increased to the new equilibrium quantity.
The equilibrium price decreased.

Shifts in Supply

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How Shifts in SUPPLY Affect the Market Equilibrium

The following example illustrates how a change in supply changes the equilibrium price.

Orange Juice Market Example

Most of the oranges grown in Florida are used to make orange juice. Suppose a hurricane hits Florida and destroys a large portion of the orange groves. What affect will this have on equilibrium in the orange juice market? Because orange groves have been destroyed, the supply of orange juice decreases. The SUPPLY CURVE shifts left. At every possible price, less orange juice is produced than before the orange groves were destroyed.

Since the demand curve has not shifted, the new equilibrium occurs at a higher market price and a smaller quantity of orange juice.