Key terms
- Ceteris paribus
- Ceteris paribus is the assumption that no relevant economic factors other than the one being studied are changing; the Latin means “other things being equal”.
- Economic model
- An economic model is a simplified representation of how two or more variables interact with each other.
A model strips a problem down to the variables that matter
Economists analyse problems with theories built on particular assumptions about how people behave. A theory, or model, is a simplified representation of how two or more variables interact. It takes a complex, real-world issue and cuts it down to its essentials: simple enough to understand, while complex enough to capture the key features of the situation.
The circular flow is an example. It shows the whole economy as just two groups, households and firms, meeting in two markets, one for goods and services and one for labour. Much is left out, and details such as government and trade can be added when they are needed.