Assumptions in Economics

What are assumptions in economics?

• Assumptions are initial conditions made before a micro or macroeconomic analysis is built.
• Sometimes assumptions are used for simplification
• Assumptions can be used to isolate the effects of a change in one variable on another
• Many assumptions are criticised for being unrealistic

What is the ceteris paribus assumption?

To simplify analysis, economists isolate the relationship between two variables by assuming ceteris paribus – i.e. all other influencing factors are held constant

For example - when considering the demand for a product such as electric vehicles, we might focus on the effects of changes in the price of the product itself, whilst isolating the impact of changes in factors such as real incomes of consumers, interest rates on loans to finance a car purchase and many other variables.

Behavioural economics

In October 2017, Professor Richard Thaler was awarded the Nobel Prize in Economics for placing "psychologically realistic assumptions into...economic decision-making"

Reasons why economists use assumptions in their economic models:

1. Helps to simplify analysis – helps to make the complex less daunting
2. Assumptions highlight the problem under investigation
3. Help economists to use maths in quantifying effects