Throughout this course, we're focused mainly on the Keynesian Model of Economics. Let's check out another one called the Real Business Cycle Model. Okay. So the Real Business Cycle Model of Economics, the main difference is that it focuses on changes in aggregate supply rather than changes in aggregate demand. Okay? So the Real Business Cycle Model believes that inflation and recession are caused mainly by changes in technology. So that's going to be an increase to aggregate supply or changes in the availability of resources. So generally, this could be like a supply shock. Generally, we'll think about this as a decrease in our aggregate supply. Maybe, prices have gone up for our resources or we've lost access to key resources and that is going to cause a recession like that. Okay? So that's the main reason that we have fluctuations in our economy based on the real business cycle model is these changes in aggregate supply. The other models that we've discussed, the Keynesian model, well, they believe that we have to fight recessions by increasing aggregate demand and the monetarist model believes increases in the money supply will lead to increased spending. Okay. So the other models focus on changes in spending, while this one focuses on aggregate supply. Okay? We focus on aggregate supply in this model rather than aggregate demand. So as an example, let's think of a supply shock here. So there's a supply shock where an increase in oil prices causes the input prices of many firms to increase. Okay? So oil prices have surged and now the availability of oil is much less, right? There's much higher prices which leads to lower production and employment. So we have here, we're going to have our long-run aggregate supply curve and we've got our aggregate demand curve, okay? This is our original situation and now we have this supply shock leading to a lower availability of resources and causing Long Run Aggregate Supply to fall here. Okay? So this was our first long-run aggregate supply. This is our new long-run aggregate supply. So we had this original equilibrium around here where we had this price level. So this is the price level in the economy and this is the real GDP in the economy. And we'll have this first equilibrium, price level PL1. And then the long-run aggregate supply shifts to the left, right? So this lowers, our production in the economy, which leads to lower employment and lower demand as well. So this model believes that there's this reduction in production, reduction in production. That's a cool rhyme right there. Is also going to lead to a reduction in aggregate demand. So now, aggregate demand is also going to shift to the left. Based on this lower production, there's just less demand, less employment, less money being made. And we'll have this shift left in aggregate demand as well which leads us to a new equilibrium. And but notice what happens at this new equilibrium is we have the same price level. So real GDP changed from GDP1 to this lower GDP, GDP2, based on the lower availability of resources, but the price level remains constant. That's the idea of the real business cycle is that we go through these fluctuations in aggregate supply rather than the fluctuations in aggregate demand. Aggregate supply is in this model the one that drives all of the changes in the economy. Okay? So that's the main thing to remember about the Real Business Cycle Model is that it's focused on changes in aggregate supply rather than changes in aggregate demand, that lead to the fluctuations in the economy. Cool? Alright. That's about it for the Real Business Cycle Model. Let's go ahead and move on to the next video.
24. Macroeconomic Schools of Thought
Real Business Cycle Model