Page 75 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 4.1.3 Paradox of Thrift

The word 'paradox' means a self-contradictory statement. Thrift means habit of saving. It is
often stated that 'a rupee saved is rupee earned'. According to the theory of income determination
a rupee saved is a rupee 'leakage' from the expenditure stream. According to the principal of
multiplier a rupee leakage will lead to multiple decreases in national income. Fall in income
will ultimately lead to less saving. On the basis of same reasoning less saving by a rupee will
lead to multiple increase in income, and ultimately to more saving. The paradox then is that
more saving means ultimately less saving, and less saving means ultimately more saving. We
can restate the paradox in another way: more saving results in less national income and less
saving results in more national income.

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Caution The paradox is based on the assumption that money saved is money stocked and
not invested. If a rupee saved (leakage) is invested (injection), the paradoxical fall in
saving will not take place. The saving, in fact, will increase due to multiple increases in
income.

4.1.4 Equilibrium of National Income with Government

The above analysis is based on the assumption of no government and no foreign trade. We now
relax the 'no government assumption', and assume that government participates in the economy.
Government participates directly through fiscal policy, and indirectly through monetary policy.
We analyse the participation through fiscal policy.
Fiscal policy refers to the taxation and expenditure policy. Government collects taxes, makes
transfer payments and incurs expenditure.

Aggregates

With the introduction of government, the variables aggregate income (Y) and aggregate
expenditure (AE) are modified in the following way:

Aggregate Income (Y)

Let T = Net tax = Tax - Transfer payments
G = Government expenditure
Y = Households income before tax

Yd = Households disposable income = Y - T
Households spend disposable income on consumption and saving. Therefore,
Yd = C + S .......................(1)
Given Yd = Y - T .......................(2)
From (1) and (2), we get

Y - T = C + S
Y = C + S + T

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