Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Courses
  • Find a Job
  • Home
  • Economics, Finance, & Analytics
  • Economic Analysis & Monetary Policy

Paradox of Thrift - Explained

What is the Paradox of Thrift?

Written by Jason Gordon

Updated at June 23rd, 2022

Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Marketing, Advertising, Sales & PR
    Principles of Marketing Sales Advertising Public Relations SEO, Social Media, Direct Marketing
  • Accounting, Taxation, and Reporting
    Managerial & Financial Accounting & Reporting Business Taxation
  • Professionalism & Career Development
  • Law, Transactions, & Risk Management
    Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
  • Business Management & Operations
    Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior
  • Economics, Finance, & Analytics
    Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles
  • Courses
+ More

Table of Contents

What is the Paradox Of Thrift?How is the Paradox Of Thrift Applied? Even More Explanation of the Paradox Of ThriftExamples of Paradox of Thrift Academic Research on the Paradox of Thrift 

What is the Paradox Of Thrift?

The paradox of thrift, also known as the "paradox of savings", is an economic theory stating that individual savings can hurt a nation's economic productivity thus causing detriment to individuals within that nation.

Back to:ECONOMIC ANALYSIS & MONETARY POLICY

How is the Paradox Of Thrift Applied? 

The paradox of thrift postulated by the British Keynesian economist, John Maynard Keynes. His theory was based upon Keynesian economic theory that productivity is driven by aggregate demand. 

Pursuant to this theory, economic productivity is based upon aggregate demand by consumers. 

  • When consumers save (rather than spend), it harms the businesses that served the needs and wants of consumers. 
  • When businesses have fewer sales, total productivity is lost. 

Thus, these businesses are unable to employ as many employees. The employees make up the consumer base. 

  • When employees begin to lose their jobs, they have less disposable income to spend. 

Thus, a cycle forms that results in lower overall productivity and worse economic conditions for the individual.

Even More Explanation of the Paradox Of Thrift

This economic theory is considered a paradox, as overall savings can be reduced due to the efforts of individuals to maximize savings. This argument starts with the assumption that total income must equal total output in equilibrium. 

Keynes claimed that the level of production and jobs did not depend on production capacity but on the decisions of people in society to spend and invest their money. He also argued that economic growth is driven by consumption or spending. 

Although reducing consumption during difficult times makes sense for individuals and families, this is the wrong approach for the bigger economy. 

Some economists disagree critique the paradox of thrift for the following reasons:

  • If demand falls, then prices fall. The subsequent lower prices increase demand and can require increased production. The principle that increased supply increases demand is known as Say's law.
  • Saving places more funds in banks. In turn, saving leads to increased bank lending. This increased lending provides capital for increased spending by businesses.
  • The paradox of thrift assumes a closed economy. It does not account for stable demand created by outside economies (such as sales in other countries).

Examples of Paradox of Thrift 

Suppose everyone gets a salary of $1,000, saves 50% and spends the other $500, which increases product demand, creates jobs, encourages entrepreneurship, and generates tax revenue for the government. 

Let us now assume that everyone is preparing for future retirement and decides to save more. They begin to save $750 and just $250 is spent. The demand for goods and services is abruptly decreasing. 

Businesses are unable to make a profit, and so they lay off workers, which increases unemployment and reduces government tax revenue. The unemployed, who now lack wages, have stopped spending entirely. This aggravates the problem, even more, leading to a downward economic spiral.

Related Topics

  • Consumption
  • Lifecycle Model of Consumption
  • Autonomous Consumption
  • Permanent Income Hypothesis
  • Income Effect
  • Lipstick Effect
  • Engel's Law
  • Consumerism
  • Paradox of Thrift
  • Ricardo Barro Effect
  • Consumer Confidence Index
  • The Wealth Effect



paradox of thrift

Was this article helpful?

Yes
No

Related Articles

  • Income Elasticity of Demand - Explained
  • Limited Flexibility Exchange Rate System - Explained
  • Absolute Advantage (Economics) - Explained
  • Incremental Cost - Explained



©2011-2023. The Business Professor, LLC.
  • Privacy

  • Questions

Definition by Author

0
0
Expand