What Is Real Business Cycle?

A closely related approach that has increasingly attracted classical macroeconomists, also relying on rational expectations and competitive markets but emphasizing different mechanism, is real business cycle theory. This approach explains business cycles purely as shifts in aggregate supply without any references to monetary or other demand side forces.       

In the real business cycle approach, shocks to technology, investment, or labor supply shift the vertical aggregate supply curve. These shocks then get transmitted into actual output by the fluctuations of aggregate supply and are completely independent of aggregate demand. Similarly movements in the unemployment rate are the result of movements in the lowest sustainable unemployment rate lower sustainable unemployment rate due to microeconomic forces such as the intensity of sect oral shocks or to tax and regulatory policies.  

According to new classical macroeconomics, the true Phillips curve is vertical. But we may observe an illusory or apparent downward slopping short run Phillips curve. Confused workers thinking that their real wages have increased work more and unemployment falls. This produces what looks like a downward slopping short run Phillips curve.