‘Other Things’ Aren’t Equal When Government Intervenes in the Economy

‘Other Things’ Aren’t Equal When Government Intervenes in the Economy
August 18, 2014

The use of the ceteris paribus, or “other things equal” assumption, is an essential aspect of economic education. It is an important caveat that helps make sense of a complicated world by clarifying the stories that comprise the core of economics. 

Unfortunately, acceptance of that phrase has also provided an opening for misrepresenting economic reality when analyzing government interventions.

Real-World Complications

At its heart, economics focuses on the implications of scarcity, which forces self-interested individuals to make choices.

If the price of a good rises (ceteris paribus), the opportunity cost of acquiring a particular good in terms of other goods foregone increases, so self-interested people will buy less of it. Similar assumptions also lead us to the parallel law of supply: If the price of a good rises (ceteris paribus), the benefits from producing and selling it rise, making self-interested people willing to incur higher opportunity costs to do so, increasing the quantity made available for purchase. 

However, when people go from learning underlying economic principles, which the “other things equal” assumption is immensely helpful in clarifying, to the complicated real world, things get trickier. People must then also confront the problem of “adding up” or detangling multiple incentive stories, when more than one incentive determinant changes over a given period of time. Training one’s focus on what happens, while assuming other things are equal, offers inadequate protection from confusion and error when other things are in fact unequal.

What, for example, happens if multiple incentive changes would each alter, say, the price of X in the same direction, other things equal? For adequate analysis, one would first have to recognize all the relevant variables, then tease out the effects of all the other incentive changes. When multiple incentive changes would change the price of X in opposite directions, both steps are again necessary. The analysis becomes much more complex.

This is one reason why translating underlying principles into more complex applications turns out to be both critically important and quite difficult. Missing just one important incentive story (an important “other thing” not equal) in an analysis can completely undermine many of its conclusions.

For example, Motel 6 room rates are higher than when the chain was founded, leading one to expect fewer rooms to be rented if that was the only relevant change. However, the prices of other goods and services and real incomes have also changed, along with other important determinants, resulting in more rentals at a higher money price than before. 

Hidden Assumptions

Perhaps the most common illustration of other things being unequal is government stimulus spending. If someone simply ignores the question of how it will be financed and the effects that follow, people trained to accept “other things equal” as their starting point can be misled.

If government spending is paid for by current taxation, those forced to bear the burdens will take home less purchasing power, which will adversely affect their demand for goods and services.

If paid for through newly created money, the tax just takes a different form. As deficits imply higher future taxes, whether to pay off or continue to fund the increased debt, they crowd out future investment and consumption possibilities. Assuming these other things will be equal when they cannot be, guarantees inaccurate analysis.

The supposed extra multiplier effects of such stimulus spending provide another example of other things being unequal. Government spending is counted as creating added income, and therefore spending, which creates more income, etc. But every iota of government-controlled resources is taken from someone. Therefore, there must be similar negative multiplier effects as well.

Protectionism

Government protectionism, favoring U.S. producers over foreign competitors, reflects the same error. It does not leave other things equal. In particular, it harms U.S. consumers by removing options they prefer. It helps some U.S. producers by harming U.S. consumers.

These examples illustrate how commonly “other things equal” assumptions hide predictable adverse effects of government “solutions.” It is important always to recognize the danger of assuming governments can change some incentives without affecting others.

Gary M. Galles (Gary.Galles@pepperdine.edu) is a professor of economics at Pepperdine University. Used with permission of the Mises Daily at Mises.org.