The correct option is 2 and 3 only.
Explanation
The "Paradox of Thrift" is a Keynesian economic concept which suggests that an increase in independent saving or the Marginal Propensity to Save (MPS) across an economy can lead to a decrease in Aggregate Demand. This paradox highlights how individual rationality (saving more) can lead to collective irrationality (lower economic output).
Statement 1 is Incorrect:
Aggregate Demand (AD) is the sum of Consumption, Investment, Government Spending, and Net Exports. Consumption depends on the Marginal Propensity to Consume (MPC). Since MPC + MPS = 1, an increase in the Marginal Propensity to Save leads to a decrease in the Marginal Propensity to Consume. A lower MPC means households spend less at every level of income. Consequently, the Aggregate Demand curve shifts downwards (or rotates downwards), reflecting reduced demand, rather than shifting upwards.
Statement 2 is Correct:
Because the Aggregate Demand curve shifts downwards due to reduced consumption, the economy reaches equilibrium at a point where aggregate demand equals aggregate supply at a lower level of activity. Therefore, the new equilibrium level of output (and income) will be lower than the initial equilibrium output.
Statement 3 is Correct:
This statement defines the paradox itself. As individuals save more, consumption falls, leading to a decline in national income. Since total savings are a function of total income, the drop in income can cancel out the effect of the higher savings rate. In a simple Keynesian model where investment is autonomous, total savings must equal total investment at equilibrium. If investment does not change, total savings in the economy will remain unchanged, despite the increased desire to save.
Key Takeaway:
The Paradox of Thrift demonstrates that an increase in the savings rate reduces consumption and Aggregate Demand, causing a fall in equilibrium income, which prevents the total stock of savings in the economy from increasing.