If all people in an economy increase proportion of income they save,…

The correct answer is Option (2) → Paradox of Thrift

For one family, saving more is wise. But when all the people of the economy try to save a larger share of their income at the same time, the total saving of the economy does not increase: it stays the same or falls. A virtue for each household brings no gain to the economy as a whole, and this result is the paradox of thrift.

It comes from the way spending and income are linked:

• Every household saves more, so consumption expenditure falls and aggregate demand falls with it.

• Through the multiplier, equilibrium income falls by more than the original cut in consumption.

• In equilibrium saving must equal planned investment, and investment is autonomous, fixed independently of income, so the economy ends up saving what it was saving before.

• If investment itself falls as income falls, total saving ends up smaller than before.

Why the other options are incorrect

• Option (1) Consumption Puzzle — Incorrect. The consumption puzzle is about the share of income consumed, which falls as income rises in data for a few years but stays steady over long periods. It concerns the consumption function, not the effect of higher saving on total saving.

• Option (3) Water-Diamond Paradox — Incorrect. Adam Smith’s puzzle about why water, on which life depends, is cheap while diamonds are dear. It belongs to the theory of value, not to income determination.

• Option (4) Investment Inefficiency — Incorrect. There is no such term.

Note: A same/similar question was asked in CUET (UG) in the papers below.

* A similar question.