Saturday  May 8, 2021
 AmosWEB means Economics with a Touch of Whimsy!
 VALUE-ADDED TAX: A tax on the extra value added during each stage in the production of a good. Most of the stuff our economy produces goes through several "stages," usually with different businesses. In each stage, resources do their thing to the good to make it a little more valuable. For example, an ice cream store can take 50 cents worth of ice cream, fudge, and whipped topping and turn it into a hot fudge sundae that's valued at \$1.50. The efforts of the ice cream resources thus add \$1 in value. A value-added tax is based on this extra value. While it's been debated off and on in the United States, a value-added tax is commonly used in Europe.

CETERIS PARIBUS:

A Latin term meaning that other factors remain unchanged. Ceteris paribus is commonly used as an assumption when conducting a wide variety of economic analyses. By holding everything else constant, the ceteris paribus assumption makes it possible to identify the cause-and-effect relation between two factors. Relaxing the ceteris paribus assumption is the primary analytical technique used in the comparative statics study of economics.
Ceteris paribus is an essential feature of the scientific method and economic analysis. Implementing the ceteris paribus assumption makes it possible to isolate the effect one factor has on another in the derivation and testing of hypotheses and principles.

### Scientific Method

The scientific method seeks to explain the way the world works by testing and verifying hypothesized cause-and-effect relations. Such relations take the form of "If A, then B." Or that "Event A causes event B."

To identify the connection between A and B it is essential that only A and B change. If event A is hypothesized to cause event B, then other possible events C, D, and E, which might affect B, cannot be allowed to change, cannot be allowed to influence B.

Consider a basic economic principle, the law of demand. This law states that quantity demanded is inversely related to demand price. Or stated in other terms, an increase in demand price causes a decrease in quantity demanded.

Suppose, for example, that focus is on the demand for hot fudge sundaes, particular the law of demand for hot fudge sundaes. The amount of hot fudge sundaes that buyers are willing and able to purchase, however, can be influenced by factors other than the price of hot fudge sundaes, including income, preferences, or the prices of other goods.

• Demand Price Changes: Suppose that the price of hot fudge sundaes increases from \$2 to \$3. The law of demand indicates that the quantity demanded of hot fudge sundaes should decrease.

• Quantity Demanded Changes: If the quantity demanded of hot fudge sundaes decreases, then this provides (presumably) confirmation of the law of demand. But what if the quantity demanded increases? Does this refute the law of demand?

• Other Factors: The law of demand cannot be confirmed or refuted if other factors that also influence hot fudge sundae demand also change. Suppose hot fudge sundae buyers have more income, which they are inclined to spend on hot fudge sundaes. Additionally, suppose the price of yogurt cones (a substitute for hot fudge sundaes) increases, prompting potential yogurt cones buyers to purchase hot fudge sundaes instead.

With these other factors also changing, testing the cause-and-effect connection between demand price and quantity demanded is impossible. It is not possible to say for certain if the change in the quantity demanded of hot fudge sundaes is caused by the higher price of hot fudge sundaes or by the change in buyers' income or by the change in the price of yogurt cones.

Using the scientific method to derive, test, and verify hypotheses, requires the ceteris paribus assumption, that other factors be kept constant.

### Economic Analysis

Although other factors are initially held constant with the ceteris paribus assumption, they are not necessarily held constant forever. A critical aspect of economic analysis is to systematically relax the ceteris paribus assumption. In so doing, the specific effect of each ceteris paribus factor can be identified and analyzed. Much like a chemist adds one chemical at a time to a mixture to determine the resulting reaction, an economist relaxes one ceteris paribus assumption at a time to observe the results.

Consider once again the demand for hot fudge sundaes. Once the law of demand is identified and combined with the supply of hot fudge sundaes, then the hot fudge sundae market can be analyzed. The equilibrium price and equilibrium quantity can be identified.

This equilibrium, however, is based on the ceteris paribus assumption. In particular, other demand factors, such as buyers' income, preferences, and other prices, are held unchanged in the identification of the equilibrium. What happens to the price and quantity of hot fudge sundaes should one of these ceteris paribus factors change?

Suppose, for example, that buyers have more income. By relaxing the ceteris paribus assumption of constant income, the effect of an increase in buyers' income on the hot fudge sundae market can be analyzed. The effect of other ceteris paribus factors can subsequently be analyzed as well, one by one. This systematic analytical approach can provide a great deal of insight into the operation of the hot fudge sundae market.

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Recommended Citation:

CETERIS PARIBUS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2021. [Accessed: May 8, 2021].

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