Fair Wages, Involuntary Unemployment and Tax Policies in the Simple General Equilibrium Model

We specify a two-sector general equilibrium model with fair wages and involuntary unemployment. In determining the fair wage, workers care not only about relative wages but also about the functional distribution of income, i.e. the wage-rental rate. With the general equilibrium cum fair wage model, we discuss the effects of tax policy and unemployment benefits on involuntary unemployment and resource allocation, and re-examine classical results on tax incidence. Among other things, we show that any tax policy that raises the wage-rental rate, like a general capital tax, lowers unemployment.