Question

1. Graphically compare the Keynesian aggregate supply curve to its positions on the production possibilities curve, respectively. Note the opportunity costs of government action and the effects on output and inflation. (Just do the Keynesian case…skip the classical).

Answer 1

Long Run AS curve is initially upward sloping and then becomes parallel to the y axis as per Keynesian theory. Since Keynesian theory states that prices and wages are sticky in the short run as a result the aggregate supply curve is upward sloping.
In the figure above as output rises so does the labour requirement and so does the prices as per movement along the AS curve. Increase in proce from P1 to P2 reduces the real wage rate and leads to an increase in quantity of labour demanded.

According to keynesian theory in the short run disequilibrium in the economy due to fall in the AD can be rectified by government intervention but those interventions have opportunity cost like
Deficut financing can lead to an inflation trap, higher government spending can lead to a high government debt, crowding out effect on private investment are some of the prominent opportunity costs depending on the nature of the economy.