Is The Fallacy Of Composition

What is the fallacy of composition? In my opinion, the "fallacy" is the general term for reasoning that can seem to correct, but it is really unsound and confusing. Of course, the most thoughtful part of the subject, like economics, is learning to sort the fallacies out from the other confusing reasoning. So, the fallacy of composition is reasoning that says because one person in the crowd can do it, everyone in the crowd can do it.

Here is an example. Every week you save an extra $10 from your paycheck. At the end of a year, you will have saved an extra $520. However, if everyone tries to save an extra $10 a week, at the end of year, we would not have tens of billions in extra savings. Why? Because what makes sense for one person to do does not make sense for everyone to do. If everyone tries to save more, everyone is cutting back on consumption. Business sales fall by hundreds of millions of dollars a week.

Moreover, if 130 million people each cut back by $10 a week, that comes to a weekly reduction of $1.3 billion. Over the course of a year, this will add up to $67.6 billion! This $67.6 billion decline in consumption will have a multiplied effect on GDP. If the multiplier is 4, GDP will decline by $270.4 billion; if it is 6, GDP will decline by $405.6 billion. Surely such declines are typical of depressions.

When retailers get the idea that business will be off over the next few months, they do two things: lay off employees and cut back on their inventory. The workers who lose their jobs cut back on their consumption. Meanwhile, the retailers have begun canceling their orders for new inventory, prompting factories to lay off people and cut back on their orders for raw materials. As the recession spreads, more and more people get laid off, and each will cut back on his or her consumption, further aggravating the decline in retail sales.

As the result, millions of people have been laid off and millions more are on reduced