What Is Real Business Cycle Theory?

           The newest theory of the business cycle in 1990's is known as real business cycle theory. According to some recent economists like Robert and Plosser the economic fluctuations are caused by fluctuations in productivity. According to these economists the productivity fluctuations are mainly the result of fluctuations in the pace of technological change. The other factors which bring changes in business activity are international disturbances climatic fluctuations, natural disasters and oil shortage. These economists however stress that far reaching technological change is the main initial factor in decreasing productivity and triggering a recession. Ultimately such technological change creates both jobs and businesses and brings massive gains in productivity.

           A wave of technological change makes some existing capital obsolete and temporarily lowers productivity. Firs expect the future profits to fall. With lower profit expectations they reduce their purchases of new capital. They lay off some workers also. So the initial effect of technological change is temporary fall in production, decrease in investment demand and decrease in the demand for labour. On the average the technology advances and adopted in the country, productivity begins to grow. Employment and output increases. In brief economic fluctuations that are ups and downs swings of business cycle are mainly caused by technological changes.