Before we start with Real Business Cycle (RBC), let us know what is Business Cycle and itsmain characteristics. This will help us to understand the topic better. Fluctuation in economyactively is a feature of every economy and poses a persistent problem, especially in the short run.These short run fluctuations in economic activity, which are reflected in output and employmentlevels, are called business cycles. Business cycle typically goes through a phase of low levels of economic activity called
which, if not remedied, will deteriorate into a
.After this phase, the economy begins to look up with the economic activity gradually peaking.The phase is called
This is followed by a downturn in economic activity, spurred by somepanic factor. Recession then once again steps in and the cycle continues. While these upturns anddownturns exist in every business cycle, what cannot be predicted at all is the period for whicheach phase would last. Recession could last for a few weeks or a few years.The onset of a business cycle and the phase that it is at a point in time is charted by looking at themovements in the Real GDP (Gross Domestic Product) growth rates. A GDP of an economy canbe based described as the final value of goods and services produced in an economy in a givenperiod. It could be better to say, beforehand that for Real Business Cycle both GDP and GNP(Gross national Product) should be considered. Now, GNP will be described very shortly ,but if we were to take snapshots of an economy at different points in time, no two photos would look alike. This occurs for two reasons:1.
Many advanced economies exhibit sustained growth over time. That is, snapshots takenmany years apart will most likely depict higher levels of economy activity in the later period2.
There exist seemingly random fluctuations around this growth trend. Thus given twosnapshots in time, predicting the later with the earlier is nearly impossible.A common way to observe such behavior is by looking at a time series of an economy¶s output,more specifically gross national product (GNP). This is the final value of the goods and servicesproduced by nationally owned factors of production.A business cycle is identified as a sequence of four phases , such as in Fig 1: