Explain in brief the salient features of real business cycle theory. In what respects is it different from other theories of business cycle?

Features of Real Business Cycle (RBC) theory :

• Technological Shock: A real business cycle is generated in a steady state economy when there is a positive exogenous and permanent technological shock. This leads to increase in productivity. As a result, the aggregate production function shifts upward. In this way, the economy continues to expand when consumption, investment and output increase gradually leading to a steady state.
• Labour Market: The real business cycle theory emphasizes that there is inter-temporal substitution of labour in the labour market. When a technology advance leads to a boom, the marginal product of labour increases. There is increase in employment and real wage. In response to a high real wage, workers reduce leisure. On the contrary, when technology is unfavorable and declines, the marginal product of labour, employment and real wage rate are low. In response to a low real wage, workers increase leisure. Thus an important implication of real business theory is that the real wage is pro-cyclical.
• Interest Rate: The real business cycle theory also takes into account the role of real interest rate in response to a technological shock. The real interest is equal to the marginal product of capital. When a favorable technological change leads to a boom, the marginal product of capital and the real interest rate rise. On the contrary, an unfavorable technical change leading to ____ ___ _______ _____ ______ ______ __________ __________ _____ __________ ______ ____.
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