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IAI Actuarial Core Principles · Business Economics · Relationship between economics and business

Each household in an economy decides to save more of its income, which is individually sensible for each household. If the result is lower total spending, lower national income and ultimately lower total saving, this illustrates which idea about the micro-macro relationship?

This illustrates the fallacy of composition, where behaviour that is sensible for one household becomes self-defeating when all households do it. Higher saving by everyone reduces total spending and national income, so aggregate saving can fall, showing micro logic does not always carry to macro outcomes.

  1. AThe law of diminishing marginal returns
  2. BThe fallacy of composition, where what is true for the individual part is not true for the wholeCorrect
  3. CComparative advantage between two countries
  4. DThe principle of opportunity cost for a single firm
  5. The Coase theorem on externalities

Explanation

The paradox of thrift shows that an action beneficial for one household, saving more, can reduce aggregate demand and income when everyone does it. This is a fallacy of composition: reasoning from the part to the whole fails. The other concepts do not describe this aggregation problem.

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