Real Business-Cycle Theory Lecture Notes

Introduction to Real Business-Cycle Theory (RBC)

• Definition: RBC theory focuses on negative supply shocks rather than monetary policy.
• Historical Context: Explains most historical business cycles, particularly in economies highly dependent on agriculture.

Key Concepts of RBC

• Real vs Monetary: The term "real" contrasts with "monetary," not "phony."
• Negative Supply Shocks: Central to RBC; these include events like poor harvests due to bad weather.

Examples of Negative Supply Shocks

• Historical Economies:
  • Example: Bad rainfall leading to poor agricultural output.
• Modern Economies:
  • 1973 Oil Crisis: Higher oil prices led to increased production costs, reduced output, and a recession in the US.
  • Brazil's Recent Economic Decline:
    • Falling commodity prices affecting national income.
    • Poor governmental policies increasing economic risk.

Graphing Real Business Cycles

• Aggregate Demand and Supply Model:
  • Long-run Aggregate Supply Curve: Shifts left, indicating lower output levels.
  • Aggregate Demand Curve: May also shift left over the medium term, exacerbating problems.

Solutions to Negative Supply Shocks

• Preventive Measures:
  • Invest in alternative energy to combat oil price shocks.
  • Increase economic flexibility to quickly adjust to shocks.

Limitations of RBC Theory

• Scope:
  • Does not explain all business cycles, particularly those involving monetary policy, banking, and credit.
• Unemployment:
  • Struggles to explain persistent high unemployment across business cycles.
  • Often requires supplementary theories for comprehensive explanations.

Conclusion

• Effectiveness: RBC theory is valuable for many cases but not exhaustive.

Additional Resources

• Practice questions and further videos from Marginal Revolution University.

Takeaway: Real Business-Cycle Theory offers significant insights into many economic cycles driven by supply-side factors, yet it is not a catch-all explanation and has its limitations, particularly concerning monetary influences and unemployment.