Question

The Paradox of Thrift theory states that free marketeers think that saving is better than spending because when people choose to save, the banks will then have more capital to invest in new technologies and even if those technologies may cause unemployment to rise, the decrease in wages will become an incentive for business to hire more employees, causing unemployment rate to fall back. Do you agree with this idea? Why?

Answer 1

The paradox of thrift is a concept introduced by J.M Keynes. There is a common belief that when people save more, more funds are available to the banks for lending. This increased lending at low rate of interest stimulates investment and the level of income and output and employment increase. But Keynes criticizes this concept on the ground that the aggregate income, output and employment depends upon the aggregate demand. Among the components of aggregate demand, the major component is consumption demand. When the people save more the aggregate demand falls which leads to the fall in investment even though more funds are available to invest. In such situation of lack of demand, the question is who will invest if there is unsold goods?.

Thus in the absence effective demand, no entrepreneur will hire workers even if the wage rate is low. So in an economy having larger tendency of thrift will suffer from increased unemployment, and decreased income, output and slow growth rate.

Thus the thrift is not a wise action to increase output and reduce unemployment.