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Macroeconomics. The financial elements - Essay Example

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Economics as we know is the art of managing the financial elements in such a manner that forces of demand and supply make a delicate balance. Economics is further subdivided in macro and micro-economics. Thrift is an integral part of this arrangement which calls for sensible and cautious management of money and goods so that wastage is minimized while maximizing the value…
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Macroeconomics. The financial elements
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Download file to see previous pages If everybody in the population starts saving the money, then ideally that should result in an overall higher levels of savings. But John Maynard Keynes, the famous economist, studied this very aspect of thrift and pointed out an interesting paradox. Keynes inferred that if everyone starts saving during times of recession then that would result in falling of the aggregate demand, which in turn will result in lowering the value of total savings in the population and leads to fall in economic growth. He meant to say that thrift is virtuous only up to a limit. The paradox is that an increase in saving, which is a recommended microeconomic strategy when individuals encounter problems, is not the best macroeconomic course of action for the aggregate economy1.
Therefore, when people try to increase their savings, it may lead to decrease in the levels of autonomous consumption which in turn will decrease the equilibrium income, thus decreasing the induced savings. This way the two components of the savings tend to cancel out each other, implying that even though people tried to increase their savings, the result happened to be a drop in equilibrium income and a 'no change' in savings. That means trying to save more doesn't necessarily result in more saving. It results, instead, in less income out of which to save. Some of the steps involved in this situation and the effects that a chain reaction sets out after such a paradox are;

Everybody starts saving his money without spending any of their income.
The markets remain idle, as there are no customers and nothing is being sold.
Since nothing is being sold, the shop owner starts feeling the pinch and fires his sales-boys and sales-girls. Gradually everyone loses their job.
Similarly the production of goods also comes to a halt, and there too employees start loosing their jobs.
There is no income as such
And since there's no income there is no saving as well.
That effectively results in zero savings.

This is what John Maynard Keynes studied and objected to. This can further be demonstrated with the help of the Injections-Leakages Model diagrams as shown in the following figures;

Fig: The Injections-Leakages Model
The two figures shown here depict the paradox of thrift in a convincing manner. For example, if to start with the saving line indicated by 'S' has a positive slope showing gradual increase in savings from a negative saving figure (i.e. expenditure) to a positive saving figure, then the equilibrium of production is achieved by a production of $12 trillion i.e. at the intersection of S and I. Now, anticipating an impending recession, the community (or group of consumers) start increasing their levels of saving i.e. they are now little more on the thrifty side, by curtailing their expenditure plans. Therefore, the community is able to save an amount of $1 trillion more (see fig-2). The saving line is shifted upward and so the point of equilibrium is also shifted. The new saving line intersects original investment line at $8 trillion of aggregate production. This new equilibrium is therefore $4 trillion less than the original equilibrium. As compared to an increase in net saving by $1 trillion, there is a ...Download file to see next pagesRead More
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