The Paradox of Thrift
The paradox of thrift highlights a situation where rational individual actions, when performed collectively, lead to undesirable macroeconomic outcomes. While a single household can successfully increase its savings by consuming less, if all households attempt to do so simultaneously during a downturn, the result can be a decrease in total economic output and potentially even lower overall savings. This occurs because the collective reduction in consumption, modeled as a fall in autonomous consumption (), lowers aggregate demand. This paradox holds true if the increase in the saving rate is not matched by a corresponding increase in investment or other sources of aggregate demand, like government spending. The initial drop in spending triggers a downward multiplier process, leading to a larger decrease in national output, income, and employment, thereby worsening the recession.
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