Question

1) What is the Real Business Cycle Theory say about business cycles? 

2) How is the Real Business Cycle Theory different from the Keynesian school of thought? 

3) How is the Real Business Cycle Theory different from the Keynesian school of thought? 

4) What are the strengths of the Real Business Cycle Theory? 

5) What are the weaknesses of the Real Business Cycle Theory?

Answer 1

1)

Real Business cycle theory says that business cycles are created by the technological and productivity shocks. Demand side does not affect business cycle. Hence, government can not address business cycle by tackling aggregate demand.

Focus must be on supply side to address the problem of business cycle.

2)

Keynesian school of thought, believes that business cycles are caused by the change in aggregate demand. Fall in aggregate demand leads to fall in output and rise in unemployment. So government intervention can help to increase aggregate demand. so unemployment issue can be addressed.

3)

Real business cycle theory does not match with monetarists as well. Monetarists believe that change in money supply causes the business cycle in economy. Fall in money supply might cause recession in economy and excessive rise in money supply would cause rise in inflationary pressure.