In an economy, C = 30 + 0.75Y and investment is 20. People become mor…

In an economy, C = 30 + 0.75Y and investment is 20. People become more thrifty, and the MPC falls to 0.5, with autonomous consumption and investment unchanged. What are the new equilibrium income and the total saving at the new equilibrium?

Answer & explanation

Correct answer: option 1

The correct answer is Option (1) → Income 100; saving 20

Equilibrium income is (C̄ + I) / (1 − c), and saving is Y − C.

Before (c = 0.75):

\( \displaystyle Y_1 = \frac{30 + 20}{1 - 0.75} = 200 \)

\( S_1 = 200 - (30 + 150) = 20 \)

After (c = 0.5):

\( \displaystyle Y_2 = \frac{50}{1 - 0.5} = 100 \)

\( S_2 = 100 - (30 + 50) = 20 \)

Income falls to 100, and total saving stays at 20. This is the paradox of thrift: people try to save more but end up saving the same.

Option (1) Income 100; saving 20 — Correct. Income 100 and saving 20.

Option (2) Income 150; saving 20 — Incorrect. 150 is not the new equilibrium; Y = 50 / 0.5 = 100.

Option (3) Income 150; saving 45 — Incorrect. Income 150 is wrong, and saving at equilibrium is 20, equal to investment.

Option (4) Income 100; saving 50 — Incorrect. Saving of 50 would be half of income; but S = 100 − 80 = 20, because autonomous consumption 30 is also spent.

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.”

“Paradox of Thrift … But that means the new equilibrium output of the economy is only Y*₂ = 100. 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. …”