Question

Use the Marginal Propensity to Save (MPS) to explain the ‘paradox of thrift’.

Answer 1

Paradox of thrift was explained by Keynes based on his theory that economic downturn is demand based. The paradox implies that during economic recession, individuals save more or have higher propensity to save which leads to lower consumption and even more lower output and stagnant production. The thrift to save more on individual basis is generalized for the entire population and this belief settles for the paradox that total savings would change according to marginal propensity to save for an individual. This is similar to prisoner's dilemma where gains from cooperation are more than the rewards from pursuing self interest and in this case it is in individual self interest to save more during recession.