The growth of nations depends crucially on saving and investment. And from youth we are taught that thrift is important and that "a penny saved is a penny earned." But will higher saving necessarily benefit the economy? In a striking argument called the paradox of thrift, Keynes pointed out that when people attempt to save more, this will not necessarily result in more saving for the nation as a whole.
To see this point, assume that people decide to save more. Higher desired saving means lower desired consumption, or a downward shift in the consumption function. Illustrate how an increase in desired saving shifts down the TE curve in the multiplier model of
Figure 22-7. Explain why this will decrease output with no increase in saving! Provide the intuition here that if people try to increase their saving and lower their consumption for a given level of business investment, sales will fall and businesses will cut back on production.
Explain how far output will fall.
Here then is the paradox of thrift: When the community desires to save more, the effect may actually be a lowering of income and output with no increase of saving.