PARADOX OF THRIFT

The value of multiplier depends upon the consumption habits of the people. Greater it the value of the propensity to consume, greater would be the generation of income in each period. Hence, the total income generated for a given increase in the initial investment would be higher, raising the value of the multiplier. This is in contrast to the views expressed by the classical thinkers that saving is a virtue rather than a vice. They were of the opinion that the people accumulate wealth by restricting consumption and increasing saving (thrift). According to them, the thrift is desirable not only for an individual consumer, but also for the economy as a whole.

Keynes refuted the idea of the classical economists and pointed out that any attempt to reduce the consumption by raising the saving of a consumer will only result in less income being passed on to the other consumer, as one person’s expenditure becomes income for another person. As a result, the increase in the saving by one person will decline the saving as well as consumption by the other person. Hence, the level of saving in the economy remains the same. Keynes argued that if all the people in the economy decide to save, the result will be a calamity for the economy, unless whole of the savings are invested. It is the idle savings that stand to blame and not the saving that are productively used for the creation of investment goods. Savings that are matched by the creation of real capital assets lie at the root of economic development. If any part of it is not invested (hoarded), it will lead to a deficiency of the demand. Consequently, the level of income, output and employment will fall. With the reduced volume of the income and employment, the community can save less. In other words, an attempt to increase the saving may be a virtue for an individual, but, saving by the whole community is disasterous for the economy.

The process can be illustrated as follows: 

 
                 
Fig. 6.1 explains the paradox of thrift graphically. In this figure, income is measured along X-axis and savings as well as investment have been shown along Y-axis. Here, investment curve II intersects original saving curve SS at point ‘E’. Both of these curves are upward sloping indicating positive relationship with income. When saving curve shifts upwards to S1 S1 with rise in savings, the equilibrium level of income comes down from OY to OY1 corresponding to new equilibrium point E1. This fall in saving consequent upon the increased attempt to save has resulted in paradox of thrift.

                                            
                      Fig. 6.1: Paradox of Thrift

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