What is the real business cycle model?
Real business cycle theory is the latest incarnation of the classical view of economic fluctuations. It assumes that there are large random fluctuations in the rate of technological change. In response to these fluctuations, individuals rationally alter their levels of labor supply and consumption.
What causes real business cycles?
The business cycle is caused by the forces of supply and demand—the movement of the gross domestic product GDP—the availability of capital, and expectations about the future. This cycle is generally separated into four distinct segments, expansion, peak, contraction, and trough.
What are the main propositions of the real business cycle model?
Real-business-cycle theory assumes that the market is undergoing variations in its ability to turn inputs into products and that these technical fluctuations trigger changes in outputs and employment.
How are shocks amplified and propagated over time in the real business cycle model?
Cycles are created by exogenous productivity shocks (impulse mechanism), which are amplified by propagation mechanisms such as intertemporal substitution, consumption smoothing, investment lag, or inventory building.
How is the real business cycle theory different from the Keynesian school of thought?
Keynesian theory explains the reduction in welfare by a failure in economic coordination: because wages and prices do not adjust instantaneously to equate supply and demand in all markets, some gains from trade go unrealized in a recession. In contrast, real business cycle theory allows no unrealized gains from trade.
In what respect real business cycle theory is different from other theories of business cycle?
Unlike other leading theories of the business cycle, RBC theory sees business cycle fluctuations as the efficient response to exogenous changes in the real economic environment.