Et ceteris paribus

I just finished reading Contagious (2013) by J. Berger, professor at the Wharton School of Business, University of Pennsylvania. The book consists of six chapters, which he summarizes with the mnemonic acronym STEPPS.

Great book. Totally recommend. Organized similar to Influence by R. Cialdini, whom Professor Berger cites in one of the chapters. Professor Berger also cites psychologist Daniel Kahneman, founder of behavioral economics.

Kahneman’s book, Thinking, Fast and Slow (2011), is just a few books away in my reading cue. I’ve looked into behavioral economics before. It’s one of my favorites, or will be, within the broader discipline of the behavioral sciences.

All disciplines ask “How does the world work?” and then presume certain conditions about the world in pursuing the answer. Physics presumes that the world consists of some physical aspect. Biology presumes that life instinctively pursues survival and reproduction. Finance presumes that we decide given risk and reward.

Economics presumes that in making decisions, we do so rationally, that given the cost-benefit of one decision over another, we choose the one that leaves us better off.

(Philosophy doesn’t begin by presuming anything. We question everything… especially the questions themselves. It’s a lot of fun.)

Kahneman illustrates a twist on the presumption of rationality in economics. I wouldn’t say that behavioral economics throws out the traditional economic models of supply and demand, or more specifically marginal cost versus marginal benefit in microeconomics.

Rather, it focuses the lens on what we call the et ceteris paribus – the “all else equal.” In our everyday lives, it’s just really, really difficult to control for all else equal in decision-making. I’d say that rationality is to the right reasons we want the world to know about, what psychology is to the real reasons that we either don’t know about ourselves or do but don’t want others to know about.

Here’s an obvious one. Economics, like any discipline, gets specific with its terms of art. An economist wouldn’t say that price affects demand; price affects quantity demanded. Changes in price or quantity mean movement along the supply or demand curves. Everything other than price or quantity, that’s what affects (shifts) the supply or demand curve.

Yet, in our lay understanding of decision-making, experience tells us that price does affect demand. Higher prices generally signal higher quality or higher desirability; meaning, higher demand.

I say our economic models still hold. It’s just not easy to isolate a decision with et ceteris paribus either in the world or in people’s heads.