Paradox of Thrift

If all the people in an economy increase the proportion they save (mps increases), the total savings of the economy will not increase - they will remain the same or even decrease. This is known as the Paradox of Thrift.

• When people try to save more (mps ↑), they cut down consumption.
• This leads to a fall in aggregate demand, which reduces equilibrium income.
• As income falls, the ability to save also falls.
• Result: Total/aggregate savings in the economy remain unchanged or may decrease.

The Paradox of Thrift

\[Y^*=\frac{\bar{A}}{1-mpc}\]

where,

• \[\overline{A}\] = Autonomous expenditure
• \[Y^∗\] = Equilibrium income
• mpc = Marginal propensity to consume

Initial Situation (Equilibrium 1):

\[Y_1^*=\frac{\bar{A}}{1-mpc}=\frac{50}{1-0.8}=250\]

After Change (Equilibrium 2):

People decide to save more → mpc falls from 0.8 to 0.5

Aggregate consumption expenditure falls by 75.

This triggers a chain (multiplier) reduction in output:

\[75+(0.5\times75)+(0.5)^2\times75+\cdots=\frac{75}{1-0.5}=150\]

\[Y_2^*=\frac{50}{1-0.5}=100\]

Conclusion of the Example

• Income fell by 150, yet aggregate savings stayed at 10.
• This confirms trying to save more does not increase total savings.

\[\Delta Y=\frac{\Delta A}{1-mpc}\]

where,

• \[\Delta A\] = Change in autonomous expenditure
• mpc = Marginal propensity to consume

mpc + mps = 1

where,

• mpc = Marginal propensity to consume
• mps = Marginal propensity to save

• The Paradox of Thrift states that higher individual saving does not lead to higher aggregate savings in the economy.
• When mps rises (mpc falls), equilibrium income falls through the multiplier chain.
• The multiplier chain is an infinite convergent geometric series.
• Aggregate savings remained at 10 in both equilibria, confirming the paradox.
• This is a Keynesian concept under the topic of Income and Employment Determination.