Thrift means saving and the paradox of thrift shows how any attempt by a community to save more out of its current income will ultimately result in a lower saving by the community as a whole.
Saving means the excess of income over consumption or the difference between the income and the expenditure on consumer goods. If, for example, an individual’s income is $500 and his expenditure is $460, his saving is $40. Similarly, the saving for the whole economy is difference between the income of the community and its expenditure over consumption. If the income of a community is $100 million and its and expenditure on consumption is $75 million, then its saving are $25 million. Thus, there is a perfect similarly between individual household savings and the community savings which may be regarded as a sum of the savings made by individuals in the economy.
This paradox can also be explained in terms of saving investment equality and equilibrium level of national income. In the diagram below II is the investment curve which intersects the saving curve SS
at point E to give OM level of national income. If the community tries to save more at each level of income, the saving curve is shifted upward to the position S'S'
The new saving curve shows that at the earlier level of income OM, now the saving are more than the investment. Due to these excess savings, this equilibrium becomes unstable at E’ where savings are equal to the investment and income level is ON. This reduction in income level has caused saving to fall from RM which the community sought to save at the income level OM to a lower level E’N. Thus, an attempt to save more by the people as whole has resulted in a lower actual saving. Thus, the paradox of thrift shows that whatever is true for an individual or a family may not be true for all the individual taken together or community as a whole.
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