Definition of General Equilibrium

In economics general equilibrium theory attempts to explain the behavior of supply, demand and prices
in the whole economy with several or many interacting markets with set of prices existing that will
result in an overall equilibrium. The general equilibrium analysis focuses on the question of how
markets in an economy allocate resources. The analysis was built on the theory of consumer and
producer behavior in economy where workers supply skills; employers demand labor( skills) and wages
paid as price for labor.
The effect of tax on interest (capital) and wages (labor) will depend on the elasticity of demand and
supply. Producers assuming cost minimizing behavior whilst households optimization of utility.
Imposition of tax on wages will alter the equilibrium of the economy in the sense that supply of labor
will be reduced in terms of working hours and actual number of people employed.
The Effects of Tax on wages
Fig A.










At equilibrium in the labor market where productivity is at full capacity, the Supply of labor is equal to
the demand for labor. In fig A we have the optimal level in the labor at point "a" where the employers
are willing to pay (w) and number of employees (Q) are willing to take the jobs. The introduction of a
wage tax will shift the supply curve to the left arriving at a new equilibrium point "b" where total
employment falls from Q to Q1 since at this point the employers will not want to incur more cost on
wages so the wages of the employees will fall to (wt-t).
In essence this leads to a reduction in total employment making it an inefficient policy as the total
productivity of labor will be reduced.
This policy will not only discourage people from working, it will also lead to early retirement, discourage
saving as employees will have less disposable income

Labor
Wage
w
w+t
D
S1
S
Q Q1
a
b
wt-t
Tax on interest (return to capital)









The imposition of tax on interest (return to capital) may reduce supply of saving or stock of capital,
which in turn may reduce productivity of workers and in turn wages in the sense that households/labor
will be encouraged to consume more than saving, which is expected to lead to a shortage of capital and
thus increase the price of capital (interest).

Conclusion
The imposition of tax on labor and capital have both negative and positive effect, Its can be used to
reducing inequality among the household and on other hand its can bring negative impact like improper
allocation of resources result from effect of change in general equilibrium.
K*
Interest
S1
S
r+t
r
D
Fig B.
a
b
Capital/Saving
s
K
rt-t