The Real Business Cycle Theories. The real business cycle theory has been evolved out from the American new classical school of 1980 s. It’s outcome of research chiefly by Kydland and Prescott, Barro and King, Long and Plosser, and Prescott. Later, Plosser, Summers, Mankiw and several other economists gave their views of the real business cycles. They view aggregate economic variables as the results of the decisions made by many economic agents acting to maximize their usefulness subject to production possibilities and resource constraints. Their perspectives mainly relate to technological shocks, labour market, interest rate, role of cash, fiscal policy, prices and wages in business cycles.
The theory of real business cycles explains short run economic fluctuations determined by the assumptions of the classical theory. According to the theory, business cycles would be the natural and efficient response of the economics to economic environment. They’re mainly caused by real or supply side shocks that involve exogenous large arbitrary changes in technology. An initial shock in the shape of a technological progress shifts the production function upward. This leads to increase in available resources, investment, ingestion and real output. With the escalation in investment, the capital stock increases that further increases real output, ingestion and investment. This process of expansion of the economics carries on erratically due to changes in technology with time.
According to Plosser, It’s a purely real model, driven by technology disturbances, and therefore, it’s been labeled a real business cycle model. There’s a single commodity in the economy. Prices and wages are flexible. Money supply and price level don’t influence real variables like output and employment. Fluctuations in employment are voluntary. Population is given. So there’s fixed labour force. There would be rational identical economic agents in the economy. These agents make optimizing decisions. All of us have got the same personal preferences which depend only on ingestion in every year. More ingestion is preferred to less so the marginal utility from consumption diminishes.
10. The economics is subject to irregular real supply side shocks. 11. It’s a single sector economy. 12. There are significant changes in the rate of technology that influence the whole economy. 13. There’s constant return to scale production technology. 14. The economics is in a steady state. Where Y is total output, Z is the state of technology, K is predetermined capital stock and N is labor input. The produced output can either be consumed or invested. Assuming that population is given and there’s a fixed labour force, output depends upon technology and capital stock. So output is based on the production function, Y= Zf .The capital stock, K depreciates at the rate S, so the undepreciated capital stock evolves as K.This capital stock can be obtained as input for production within the next period.