Paradox of Thrift

Paradox of Thrift - The Paradox of Thrift S' $ S I Total S...

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Unformatted text preview: The Paradox of Thrift S' $ S I Total 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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