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Real Business Cycle Theory Explained

This document discusses the two-period model and the real business cycle (RBC) model. In the two-period model, the optimal saving decision of agents and the production function are defined. Equations for the capital stock over time and the steady state are derived. The RBC model is introduced. Key points are that it argues economic cycles are driven by technology and productivity shocks, unlike Keynesian models which view cycles as demand-driven. Positive transitory productivity shocks increase short-term output, while permanent shocks increase long-run output. The RBC model can explain positive output fluctuations through productivity shocks but has shortcomings for negative fluctuations.

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8 views2 pages

Real Business Cycle Theory Explained

This document discusses the two-period model and the real business cycle (RBC) model. In the two-period model, the optimal saving decision of agents and the production function are defined. Equations for the capital stock over time and the steady state are derived. The RBC model is introduced. Key points are that it argues economic cycles are driven by technology and productivity shocks, unlike Keynesian models which view cycles as demand-driven. Positive transitory productivity shocks increase short-term output, while permanent shocks increase long-run output. The RBC model can explain positive output fluctuations through productivity shocks but has shortcomings for negative fluctuations.

Uploaded by

AceroCaballero
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Problem Set 8: Towards Real Business Cycle Theory

From: Mash-Erdene Ganbold (1154248)


Exercise 1: Two-Period Model
st =

wt
2+

agent' s optimal saving decision

yt = f Hkt L = Kt production function per capita

Its known that

where MPK = f ' HkL MPN = A@f Hkt L - f ' Hkt LD


with A = 1
(a)

[Link] Condition (4.2.12): wt = YN


YN = MPN
MPK = f ' HkL = Kt-1

MPN = Kt H1 - L = wt
!

We know that capital stock changes over time as per: Kt+1 = H1 - L Kt + It with = 1 here.
kt+1 = H1 - 1L kt + it = it
kt+1 = it = st
kt+1 =

wt
2+

MPN
2+

= kt

1-
2+

(b)
i.
Kt+1 = Kt
kt*
kt*
kt*

H1-L
2+
2+

kt* = J

kt =
I
I

| : kt*

2+

|^

1-

H1-L
2+

1
1-

1- 1-
N
2+
1

&

wt
1-

wt
M
1-
1

=J

|^

1- 1-
N
2+
1

wt
1- 1-
M=J
N
1-
2+

wt = H1 - L J
iii.

|:

1-

kt*-1 =

ii.

= kt*

kt* = 0

kt* = I

wt
M
1-
1

| ^

|(1-)

1- 1-
N
2+

= wt*

We know that as per (4.2.14): y 'k+1 = r +


For = 1: y 'k+1 = r + 1
steady state:

y=y

| set equal to above equation

1-

2+

wt = H1 - L J

1- 1-
N
2+
Problem Set 8 (hand-in).nb

= wt*

iii.

We know that as per (4.2.14): y 'k+1 = r +


For = 1: y 'k+1 = r + 1
steady state:

y=y
MPk = y ' = y
k-1
=r +1
t

|-1

r = k-1
-1
t

| substitute kt-1 with kt*-1 =

r * = J

2+
1-

N-1

2+
1-

Exercise 2: The RBC Model

1. The main problem with the theory behind Keynesian models used prior to the revival of business
cycle in the 1970s was the fact that it was not consistent with how agents decided.
2. Lucas argued that outcomes depend on policy because of agents expectations. This led to the
term expectations revolution of macroeconomics. (Additionally Freedman critique states that
unemployment does not dependent on inflation in the long run)
3. Keynesian model states that cycle is demand driven and government spending can affect the
demand while in the RBC model Lucas argued if government changes behaviour now private
agents would also change its expectations.
4. Solow-Swan model of Economic Growth which is classified as a Neoclassical Model.
5. The source of variations in the RBC model usually comes from technology and productivity
shocks.
6. If theres no source of variation in the RBC model the output will converge to steady state.
7. A positive transitory productivity shock causes the output to increase in the short-term but then to
retract to the initial level.
8. On the other hand a permanant productivity shock increases the output in the long run.
9.
10. To assess the RBC model typically sample moments are used.
11. It explains especially positive fluctuations of output well attributing it to positive productivity
shocks.
12. The model has its shortcomings when it comes to explaining negative fluctuations in output
through the concept of productivity shocks as a driving force behind such a change.

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