Question

Explain the main mechanism behind the Real Business Cycle theory to explain the sequences of booms and busts of an economy. How does it differ from Bloom’s theory of cycles generated by varying uncertainty? Analyze the effects of changes in uncertainty related to the COVID-19 crisis.

Answer 1

The real business cycle theory propagates that the fluctations occuring in the market are subject to real shocks. The theory assumes that indiciduals are rational agents seeking to maximize their utility. Under this theory the individuals seek to invest in capital, hence the fluctuations in the market sphere are bought about by the changes in the capital, changes in technology, and productivity.Such changes lead to changes in investment, and hence changes in output is accounted for. The theory plays down the role of aggregate demand in an economic cyle, and emphasises supply-side factors responsible for the changes in the buisness cycle.

According to the theory of Nicholas Bloom, the occurance of the buisiness cyces in the market can be accounted much to the fluctuations in the uncertain behavior of the individuals. Macro uncertainly arises during recession, when there is enough lack of demand in the economy, stock market prices are fluctuating, the exchange rate market, bond market and everything shows their uncertain behavior. According to Bloom's theory such changes in the behavior of the individual brings about the fluctuations in the market. This view completely differs from the view of the real buisiness cycle, who makes the supply side factors respondible for the buisness cycles and oes not bother to consider the uncertain behavior of the individuals.