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Paradox of Thrift

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When households become concerned with their future savings and attempt to increase their savings, how does this effect the overall economy? What is the Paradox of Thrift?

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Solution Summary

The expert examines paradox of thrift in a household concerned with future savings. How this effects the overall economy is determined.

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The Paradox of Thrift is a fairly simple concept: We assume that when people save more, the pool of savings available to the economy will increase. This seems obvious, right?

Yet, this means that consumption decreases. As consumption decreases, economic growth slows. The income for companies operating in that economy will fall. This means of course, that these firms will have to shed jobs. They might not increase salaries or hire more people. The firms themselves might get more pessimistic about the economy as a whole.

This means that, over time, the total savings of the population will actually fall. The equilibrium between income and savings will go down, since incomes will go down across the board. A snowball effect ...

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