In an economy with C = 60 + 0.9Y and I = 40, equilibrium income is 1,…

In an economy with C = 60 + 0.9Y and I = 40, equilibrium income is 1,000. People suddenly become more thrifty and the mpc falls to 0.5. Which of the following is the odd one out, that is, NOT a result of this change?

Answer & explanation

Correct answer: option 2

The correct answer is Option (2) → At the new equilibrium, total saving in the economy rises above 40.

Given:

C = 60 + 0.9Y

I = 40

Y = 1,000

The mpc falls to 0.5

This is the paradox of thrift. People try to save more, but output falls so much that total saving does not rise.

\( \text{Fall in AD at } Y = 1{,}000: (0.9 - 0.5) \times 1{,}000 = 400 \)

\( \displaystyle \text{Total fall in output} = \frac{400}{1 - 0.5} = 800 \)

\( \displaystyle \text{New } Y = \frac{60 + 40}{1 - 0.5} = 200 \)

\( \text{Saving before} = 1{,}000 - (60 + 900) = 40 \)

\( \text{Saving after} = 200 - (60 + 100) = 40 \)

Option (1) At the initial income of 1,000, aggregate demand falls by 400. — A result. The first fall in AD is 400.

Option (2) At the new equilibrium, total saving in the economy rises above 40. — Not a result. Total saving stays at 40. It does not rise.

Option (3) Output falls by 800 in all. — A result. Output falls by 400 / 0.5 = 800.

Option (4) The new equilibrium output is 200. — A result. Output falls from 1,000 to 200.

NCERT (2026-27): “Paradox of Thrift If all the people of the economy increase the proportion of income they save (i.e. if the mps of the economy increases) the total value of savings in the economy will not increase – it will either decline or remain unchanged. This result is known as the Paradox of Thrift – which states that as people become more thrifty they end up saving less or same as before. This result, though sounds apparently impossible, is actually a simple application of the model we have learnt.”

“… People are now saving S*₂ = Y*₂ – C*₂ = Y*₂ – (C̄ + c₂.Y*₂) = 100 – (40 + 0.5 × 100) = 10 in aggregate, whereas under the previous equilibrium they were saving S*₁ = Y*₁ – C*₁ = Y*₁ – (C̄ + c₁.Y*₁) = 250 – (40 + 0.8 × 250) = 10 at the previous mpc, c 1 = 0.8. Total value of savings in the economy has, therefore, remained unchanged. …”