Instructor Name: Muhammad Yasar

GENERAL EQUILIBRIUM
LECTURE # 26
MSC ECONOMICS (EVE)
4TH SEMESTER

Prepared by Muhammad Yasar

 Source: Chapter # 3 , Microeconomic Theory by
Walters and Layard
AIMS AND OBJECTIVES
 Tax on one factor
 Effects on other factor

Prepared by Muhammad Yasar

 Real income effects
A TAX ON ONE FACTOR
 We consider here as the labor in x is the factor to be
taxed
 Also there is a perfect competition

Prepared by Muhammad Yasar

 Before we move further it should be in mind that if
the production of x increases then the factor
intensively used will gain
 We will see in terms of real incomes
 Prepared by Muhammad Yasar
DIAGRAM
VISIBLE EFFECTS
 Before tax we are at P
 Then after taxing L our efficient production disturbs
 We move to P/

Prepared by Muhammad Yasar

 A new efficiency locus generated
𝑀𝑅𝑇𝑆𝑥 > 𝑀𝑅𝑇𝑆𝑦
𝑀𝑃𝐿 𝑤𝐿 𝑤𝐿 𝑀𝑃𝐿
= 1 + 𝑡𝐿.𝑥 > =
𝑀𝑃𝐾 𝑥 𝑤𝐾 𝑤𝐾 𝑀𝑃𝐾 𝑦
QUALITY ANALYSIS
 We have to assume two things first
I. 𝑀𝑃𝐶𝐺𝑜𝑣𝑡. > 𝑀𝑃𝐶𝑃𝑣𝑡.
II. Elasticity of demand for x is more than one

Prepared by Muhammad Yasar

 After we tax the labor then we have two possibilities
I. x falls in demand little bit
II. x falls in demand alot
CONT..

I. When production occurs in the range RP/

𝐾 𝑥
• rises
𝐿
So, capital may lose from tax

Prepared by Muhammad Yasar

•

• Labor cannot gain

• Labor is not getting full payment due to tax
• This is because by imposing tax on labor cost of
production rises
𝑤𝐿 𝑤𝐿 𝑃𝑦
=
𝑃𝑥 𝑃𝑦 𝑃𝑥
CONT..

I. When production occurs in the range OR

• x falls a great deal
𝐾 𝑥
• falls

Prepared by Muhammad Yasar

𝐿
• So, capital gains from tax
• Labor cannot gain
• Capital gains die to the greatly increased
quantity of capital intensive y that is demanded
 CONCLUSION

 So, labor lose and capital gain

Prepared by Muhammad Yasar

Prepared by Muhammad Yasar
THANK YOU