What is the Paradox of Thrift

✓✓ What is the Paradox of Thrift?

The Paradox of Thrift is the theory that increased savings in the short term can reduce savings, or rather the ability to save, in the long term. The Paradox of Thrift arises out of the Keynesian notion of an aggregate demand-driven economy.

An increase in the rate of saving reduces consumption in the economy which, in turn, reduces total output (via Keynesian consumption). According to British economist John Maynard Keynes, when people save during a recession, the level of consumer spending decreases, which eventually slows down economic growth.

✓✓ Criticisms of the Paradox of Thrift

The Paradox of Thrift, while practical in its reasoning, attracted numerous criticisms from neo-classical economists. The neo-classical economists argue that a consumer saving is viewed by the market as a signal of supply-side inefficiency. A consumer saving sends the signal that the consumer DOES NOT WANT to consume any of the goods in the market at the prevailing market price.

Therefore, producers should either lower the price or change the goods and services being produced. Thus, the action of not consuming does not reduce future output but merely forces the market to optimize.

Under standard neo-classical economic growth theory, saving is essential to economic growth and technological innovation. Most modern theories of innovation argue that a threshold level of capital needs to be reached before innovation can occur. Technological innovation can significantly raise the total amount of output in an economy.

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