A two dimensional numerical model is used to compute the saturation of small scale gravity waves in the region near the critical level. The vertical wave number spectrum of horizontal velocity fluctuations in the unstable region (USR) where shear instability develops is found to be governed by wave-shear interaction and follows a theoretical saturation spectrum ~ωb2/2m3. Wave-shear interaction is also found to be responsible for the observed fact that the variance of vertical velocity fluctuations is significantly lower than the level predicted by linear gravity wave theory. On the other hand, the corresponding spectrum in the stable region (SR) following a much shallower spectrum ~m-2 is found to result from the combined effects of wave-wave interactions and eddy diffusion. The key step in our simulation is the separate parameterization of horizontal and vertical eddy diffusion coefficients instead of a constant molecular viscosity coefficient.