Paradox of Thrift

• Thriftiness, while a virtue for the individual, is

disastrous for an economy.
• If consumers seek to save a larger amount
out of any given level of income, that
attempt to save more may lead to a fall in
income leaving the amount of savings
unchanged or even decreased.
Case 1:
Investment expenditure is autonomous
Given: S = -C0+(1-b)Y
I =I0
Where C0 : autonomous consumption
b: marginal propensity to consume
 The Paradox of Thrift

I,S
S2

S1

I=I0

Y2 Y1
 C,I,G
450

C0+I+G
e 0
C1+I+G
e1

S1
S0

I=S I0

Y
Y 1
Y 0
Example
• S1=-20+(1-0.75)Y
• I=20
• At equilibrium,

• I=S
• 20=-20+(1-0.75)Y
• 40=0.25Y
• Y=160
the realized saving is:

S1=-20+(1-0.75)Y
=-20+0.25(160)
=-20+40
=20
Suppose the saving function shifts upward,

S2=-10+(1-0.75)Y
I=20
 At equilibrium,

I=S
20=-10+(1-0.75)Y
30=0.25Y
Y=120
Now the realized saving is:

S2=-10+(1-0.75)Y
=-10+0.25(120)
=-10+30
=20
 How the paradox can be resolved?
• If planned investment increases as a result of
the increase in planned saving, then there
may not be a decrease in national output.
 The Paradox of Thrift

I,S

S1

I=I0

Y1
 The Paradox of Thrift

I,S
S2

S1

I=I0

Y
Y2 Y1
 The Paradox of Thrift

I,S
S2

I=I0’
S1

I=I0

Y2 Y1