| a) A tax on interest income earned from saving reduces
the incentive to save at any given market interest rate. This implies a
leftward shift of the saving function. The equilibrium interest rate rises,
and both investment and saving are reduced. |
| b) The effect on employment depends on the time horizon
one considers. Consider first the immediate effect. At any point in time,
the capital stock is fixed, resulting from past investment decisions. Given
a fixed capital stock, labor market equilibrium requires that the marginal
product of labor equals the real wage. But nothing here depends on the
interest rate, so employment is not immediately affected by the tax on
saving. |
| c) Now consider the longer term. Investment has declined,
so we know that the capital stock will decline. And (check the answer
to question 3 for an increase in the capital stock) a reduction in
the capital stock will cause employment to decline. So, once one takes
a long enough time horizon to allow for changes in the capital stock, the
classical model predicts that a tax on saving will reduce employment. |