Question

Given:

Butter	Guns	MC
0	100
1	90
2	75
3	55
4	30
5	0

1. Complete the marginal cost column (MC).
2. Identify the opportunity cost increasing butter production from 1 to 2 units on the graph.
3. Graphically illustrate the Keynesian versus classical position of the economy and their respective opportunity costs (two graphs). Explain the policy implications of these two alternative assumptions of the economy (Per lesson notes).

Answer 1

Butter	Guns	MC
0	100	-
1	90	10
2	75	15
3	55	20
4	30	25
5	0	30

As the production of butter increases, the production of guns decreases. So it comes at the cost of the production of guns.

Note: As production costs are not given, opportunity cost is assumed to be marginal cost.

(b) As increasing the production of butter from 1 to 2 units the production of guns decreases from 60 to 75 units. So the opportunity cost is 15.

(c) In classical portion, the only factor which is considered for calculating opportunity cost is transaction demand for money, while in Keynes, both speculate demand and transaction demand are considered. Thus in the classical view, demand for money is only the function of income. Keynes, it is a function of income and interest rate.

Speculative demand is the opportunity cost of holding cash. Higher the interest rate higher the opportunity cost of holding cash.

Policy Implication

In classical, changes in fiscal policy or autonomous change in investment have no role in determining the value of income.

In Keynes, the money demand function is not proportional to the supply of money. This means that the income can change due to fiscal policy or changes in investment demand.