Question

according to real bussiness cycle theory what is the source of business cycle?what is the role of fluctuations in the rate of technological change?how do real gdp and price level change if the forecast of inflation is incorrect

Answer 1

According to real business theory, source of business cycle is real or supply side shocks that involve random changes in technology. For example oil turning cheap will cause business cycle as supply side shock takes place which causes oil to turn cheap, this causes less investment in future oil production.

Role of fluctuations help determine the pace of technological change. If the fluctuations are fast, and stable after a certain time, then technological change will occur which will be permanent, if fluctuations are volatile than rate of technological change will vary across industries where innovative ideas could replace labour.

If the forecast of inflation is incorrect. That is suppose prices are projected to rise, then people will buy more goods in the current stage and the real GDP will grow but once one gets to know that prices have not increased after all, then people will defer buying in the current stage as they know this is not the lowest level, this will lead to stagnant GDP and tepid price level change as they see there is not much demand for price level to increase and the supply is also stable.