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Unformatted text preview: The Paradox of Thrift S' $ S
S a v in g s S 2 or S 1 In v e s tm e n t Y 1 Y Y
2 The Paradox of Thrift refers to the idea that if everyone attempts to save more,
the total level of savings in the economy will actually decline. (This is the fallacy
of composition idea that we talked about earlier in the course.) Although saving
more may be a good idea for an individual, it might have a bad effect on the
economy as a whole if everyone does the same thing.
In order to illustrate the paradox of thrift idea, we draw the savings and
investment graph but this time we draw the investment curve sloping up. That
investment spending would increase with the level of income is actually a more
realistic assumption than assuming investment spending is constant with
increases in income (horizontal). If everyone saves more at a given level of
income, that means that the savings curve shifts to be above the old savings
curve at any particular level of income. Note that total savings are measured on
the vertical axis.
Although it is true that savings at any particular level of income is greater, the
economy will move to a new equilibrium after the savings curve shifts because
savings no longer equals investment at Y2. Now Savings equals Investment at
Y1 and looking at the vertical axis we see that Total Savings has dropped from
S2 to S1. When the level of Y declined, people lost jobs and income and thus
there was less money available to be saved! ...
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- Winter '11