Meanings of Paradox of Thrift.The reverse multiplier effect can be illustrated in the context of Keynes's paradox of thrift, which highlights the negative impact of higher saving in an economy in recession. Keynes said that such thrift (or conservative saving behaviour) would accentuate the recession. As people save more, they will spend less. Firms will therefore produce less, and labour hiring will, as a result, fall, leading to a decline in incomes. This decline would also happen in a multiplied fashion, causing a huge decline in national income. The paradox lies in the fact that saving, while usually considered good for any one individual, can actually be harmful to the overall economy if everyone started saving.
Illustration of Paradox of Thrift. Paradox of thrift can be illustrated using withdrawals and injections approach to output determination. Withdrawals and injections are taken on vertical axis and the output is taken on horizontal axis.
If people start saving more for a rainy day or something else, the withdrawal function will shift upwards because saving is a form of withdrawals. The withdrawal function will rise from w1to w2.However if the people save more, they will naturally be able to spend less. If the spending is less, the firms will be able to produce less. There will thus be a multiplied fall in income. The phenomenon of higher savings leading to lower national income is known as Paradox of Thrift.
Illustration of Paradox of Thrift. Paradox of thrift can be illustrated using withdrawals and injections approach to output determination. Withdrawals and injections are taken on vertical axis and the output is taken on horizontal axis.
If people start saving more for a rainy day or something else, the withdrawal function will shift upwards because saving is a form of withdrawals. The withdrawal function will rise from w1to w2.However if the people save more, they will naturally be able to spend less. If the spending is less, the firms will be able to produce less. There will thus be a multiplied fall in income. The phenomenon of higher savings leading to lower national income is known as Paradox of Thrift.