Real Business Cycle Model: Videos & Practice Problems

The main difference between the Real Business Cycle (RBC) Model and the Keynesian Model lies in their focus on economic fluctuations. The RBC Model emphasizes changes in aggregate supply as the primary driver of economic cycles, attributing inflation and recession to technological changes or resource availability. In contrast, the Keynesian Model focuses on aggregate demand, suggesting that economic fluctuations are driven by changes in consumer and government spending. While the RBC Model sees supply shocks, such as rising oil prices, as pivotal, the Keynesian Model advocates for increasing aggregate demand to combat recessions.

In the Real Business Cycle (RBC) Model, a supply shock, such as a sudden increase in oil prices, leads to a leftward shift in the long-run aggregate supply (LRAS) curve. This shift results in lower production and employment, causing a decrease in real GDP. The model posits that this reduction in production also leads to a decrease in aggregate demand, as lower employment and production reduce overall spending. Despite these changes, the price level remains constant, highlighting the RBC Model's focus on supply-side factors as the main drivers of economic fluctuations.

In the Real Business Cycle (RBC) Model, technological changes are a key factor influencing economic fluctuations. Positive technological advancements can increase aggregate supply by making production more efficient, leading to higher real GDP and employment. Conversely, negative technological changes or setbacks can reduce aggregate supply, causing lower production and employment, and potentially leading to a recession. The RBC Model views these technological changes as primary drivers of economic cycles, emphasizing their impact on the supply side of the economy.

The Real Business Cycle (RBC) Model focuses on aggregate supply rather than aggregate demand because it attributes economic fluctuations primarily to changes in production capabilities and resource availability. The model posits that factors such as technological advancements or supply shocks (e.g., changes in oil prices) directly impact the economy's productive capacity. This focus contrasts with models like the Keynesian Model, which emphasize aggregate demand and spending as the main drivers of economic cycles. By concentrating on supply-side factors, the RBC Model aims to explain how variations in production and resource availability lead to changes in real GDP and employment.

The Real Business Cycle (RBC) Model explains recessions as a result of negative supply shocks or adverse technological changes. For instance, a sudden increase in the price of key resources like oil can reduce the economy's productive capacity, leading to a leftward shift in the long-run aggregate supply (LRAS) curve. This shift results in lower real GDP and employment. The model suggests that these supply-side disruptions cause a reduction in aggregate demand as well, due to decreased production and income. Thus, recessions in the RBC Model are driven by factors that affect the economy's ability to produce goods and services.