Question

The Paradox of Thrift refers to:

• A. Higher savings lead to lower investment.
• B. Higher savings increase national income in the long run.
• C. Higher savings during recessions can reduce national income.
• D. None of the above.

Answer 1

The Correct Option is C

The Paradox of Thrift is an economic theory which suggests that while individual savings can be beneficial, increased savings across an economy, especially during a recession, can lead to reduced economic growth. This counterintuitive phenomenon occurs because:

• When individuals save more, they reduce their consumption.
• Reduced consumption leads to a decrease in aggregate demand.
• Lower aggregate demand results in decreased production, income, and employment levels.
• The economy subsequently contracts, reducing national income in the short term.

Therefore, while higher savings might seem beneficial at an individual level, during economic downturns, it can lead to a decrease in overall economic activity, exemplifying the paradox. The correct statement is: Higher savings during recessions can reduce national income.