Business cycles of an economy refers to the fluctuations in outputs and employment level of that economy.Almost all economists agree upon the fact that output remain at natural rate in the long run whereas there exists fluctuations in the short run that are not predictable.These random and irregular fluctuations in output from its natural rate are termed as business cycles.Business cycles are followed by contractions and expansions in economic activity and measured by changes in real GDP.
There exist a lot of questions regarding business cycles and thus different school of thoughts.The economists disagree upon that is why output deviate in the short run not in the long run, why the same resources yield different outputs, how some economies have more while others have less fluctuations in output and what factors work behind the booms and recessions.
There are many theories to explain the causes of business cycles the prominent of which are disequilibrium models(Keynesian) and equilibrium models(Monetarist), these models explain business cycles emphasizing on the factor demand for labor that there is lack of demand for workers and consider it the cause by stating that labor market do not clear in the short run and adjustments take time because wages and prices are sticky.If output goes down it is due to that market fails to clear pushing the economy into recession.
An important explanation of business cycles is by Real Business Cycle Theory based on the classical assumptions.
Real Business Cycle Theory explains the fluctuations in output and employment through changes in labor supply opposed to Keynesian and Monetarist view that stress upon demand for labour.Important feature of this theory is consideration of the real factors.
Real Business Cycle Theory states that business cycles occurs as a result of productivity changes occurred by real factors.The theory emphasizes the changes in intertemporal substitution of labor and technology shocks and also consider that government should not make interventions through monetary and fiscal policies as economy automatically adjusts to these changes.If the economy does not adjusts to these changes it will be in recession.
According to this theory, labor supply depends on how workers response to the incentives.Fluctuations in technology directly affects the labor productivity i.e if technology improves labor productivity and real wages increases causing the output and employment to increase and if it regress the output and employment decreases accordingly.
The theory also consider the other real factors such as natural disasters and weather conditions that can affect output.Another important point is that output and money supply move together,money supply does not effect output.
There are found some flaws in real business cycle theory but inspite of its drawbacks it is an important contribution to the understanding of concept of business cycles.
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