21) If autonomous consumption increases, the size of the multiplier would
A) increase.
B) decrease.
C) remain constant.
D) either increase or decrease depending on the size of the change in autonomous consumption.
22) In practice, the actual size of the multiplier is about
A) 1.
B) 1.4.
C) 2.
D) 4.
23) Related to the Economics in Practice on p. 472: According to the “paradox of thrift,” as individuals increase their saving,
A) income in the economy increases because there is more money available for firms to invest.
B) income in the economy increases because interest rates will fall and the economy will expand.
C) income in the economy will remain constant because the change in consumption equals the change in saving.
D) income in the economy will fall because the decreased consumption that results from increased saving causes the economy to contract.
24) Related to the Economics in Practice on p. 472: According to the “paradox of thrift,” increased efforts to save will cause a(n)
A) increase in income and an increase in overall saving.
B) increase in income but no overall change in saving.
C) decrease in income and an overall decrease in saving.
D) decrease in income but an increase in saving.
25) The larger the MPC, the smaller the multiplier.
26) The smaller the MPS, the larger the multiplier.
27) If the MPC is 0.75, then the multiplier is 4.
28) If the MPS is 0.1, then the multiplier is 10.
29) An increase in the MPC, reduces the multiplier.
30) Related to the Economics in Practice on p. 472: The paradox of thrift is that all people deciding to save more could lead to them saving less.
The Correct Answer and Explanation is :
Here are the correct answers:
21) A) increase.
22) B) 1.4.
23) D) income in the economy will fall because the decreased consumption that results from increased saving causes the economy to contract.
24) C) decrease in income and an overall decrease in saving.
25) False. (The larger the MPC, the larger the multiplier.)
26) True.
27) True. (Multiplier = 1 / (1 – MPC) = 1 / (1 – 0.75) = 4)
28) True. (Multiplier = 1 / MPS = 1 / 0.1 = 10)
29) False. (An increase in MPC increases the multiplier.)
30) True.
Explanation (300 Words)
The paradox of thrift is a key concept in Keynesian economics, illustrating how increased individual saving can lead to an overall decline in total savings in the economy. The paradox arises because, in the short run, one person’s spending is another person’s income. If many individuals simultaneously decide to save more and reduce their consumption, demand for goods and services will fall. This reduction in demand leads to lower production, layoffs, and decreased overall income in the economy.
When income decreases, people have even less money to save, and paradoxically, the total amount of savings in the economy may decline rather than increase. This contradicts the intuitive belief that higher savings always result in greater wealth accumulation.
In contrast, when consumption is strong, firms earn more revenue, leading to higher wages and employment. This boosts total income and, in turn, increases savings as a portion of that income. Keynes argued that in a recession, government intervention—through fiscal policies such as increased public spending—could counteract the negative effects of excessive saving.
The multiplier effect plays a role in this paradox. The multiplier depends on the marginal propensity to consume (MPC) and the marginal propensity to save (MPS). A higher MPC results in a larger multiplier, meaning that changes in spending have a more significant impact on total income. Conversely, a higher MPS (lower MPC) means that a greater portion of income is saved rather than spent, reducing the multiplier’s effect on overall economic growth.
Thus, while saving is essential for long-term investment, excessive saving during economic downturns can lead to reduced income and lower total savings, highlighting the paradox of thrift.