Question

what happens to the equilibrium level of GDP if all the individuals in this experimental economy decide to spend less and save more? what effect does this have on the actual level of total saving in future onwards?

Answer 1

If all the individuals in this experimental economy decide to spend less and save more then it can impact the economic growth of the country too. In the short run, If people start saving more, it would be considered productive as saving is equal to investment so increased savings would allow banks to lend more and investment would increase. But this mechanism would be beneficial for the economy to a certain level(in short run only)as if everyone starts saving only in the long run so it would lead to fall in the aggregate demand resulting in stagnation of economic growth at some point of time and consequence of this would be recession as more saving resulted in reduced demand so firms will start firing the workers, people would lose their jobs and would demand less causing a lot of social problems like unemployment and poverty.

In the short-term, a rapid rise in savings could cause a fall in consumer spending which can lead to a recession in the long run.

if everyone saves at once, it can cause a drop in aggregate demand and cause a recession. Keynes called it the Paradox of Thrift.

There is also the paradox of savings – people save more when they think it’s a bad time to save and save less when it’s a good time to save.