The paradox of thrift; full employment

The paradox of thrift: if everyone tries to save a larger share of their income, total saving in the economy does not rise. It stays the same, or even falls.

Why? Saving more means spending less. Lower spending lowers demand, and lower demand lowers income, until saving is back where it was.

Example: C̄ = 20, Ī = 30, c = 0.75. Equilibrium Y = 50 ÷ 0.25 = 200; consumption = 20 + 150 = 170, so saving = 30.

Now people become thriftier, and c falls to 0.5. New Y = 50 ÷ 0.5 = 100; consumption = 20 + 50 = 70, so saving = 30 again. Income has halved, and saving has not risen at all. (In equilibrium, saving equals investment, which has not changed.)

Full employment income is the level of output at which all the economy's factors are employed. Equilibrium income need not be at full employment.

• If equilibrium is below full employment, there is deficient demand. In the long run, it pushes prices down.
• If planned demand is more than full employment output, there is excess demand. Output cannot grow further, so in the long run prices rise.