Real Business Cycle Theory
Business cycles as efficient responses to technology shocks, the provocation that built modern macro.
Definition
RealrealAdjusted for inflation, measured in actual purchasing power. Business Cycle theory: fluctuations as optimal responses of rational agents to technology shocks, in a frictionless flexible-price economy, cycles without market failure.
Key equation
Core mechanism: TFP shock → MPL↑ → work more today (intertemporal substitution) → output amplifies
The intuition
If productivity is temporarily high, it's rational to work and invest extra now and rest later, so even efficient economies fluctuate. The provocation: if cycles are optimal, stabilization policy is pointless. New Keynesians answered by adding sticky pricessticky pricesPrices and wages that adjust slowly, giving demand shocks real short-run effects. back.
Exam tip
Know the two standard critiques: measured 'technology regress' in recessions is implausible, and labor supply isn't that elastic.
Want this one as a full interactive graph? Votes decide the build order, and an email means we can tell you when it ships.