LOS g: Describe mainstream business cycle theory and real business cycle (RBC) theory and distinguish between them, including the role of productivity changes.

Mainstream business cycle theory states that business cycles are caused by changes in aggregate demand. If aggregate demand would remain steady over time rather than fluctuating, the magnitude of business cycles would be reduced greatly. Real business theory states that business cycles are due to fluctuations in worker productivity, which in turn is caused by the variability of technological changes.

Real business cycle theory proposes that potential real GDP fluctuates as worker’s productivity fluctuates. Mainstream business cycle theory states that the growth of real GDP will remain fairly stable over time.

New classical economists believe that only unexpected changes in demand cause economic cycles. New Keynesian economists believe that both expected and unexpected changes in demand lead to business cycles. Monetarists believe that fluctuations in aggregate demand are due to the variability of the growth rate of the money supply.