Review on Understanding Real Business Cycle

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Review on "Understanding Real Business Cycle" by Charles I. Plosser

In the journal of Economic Perspectives – Volume 3, Number 3 – Summer 1989 – Pages 51 – 77, Charles I. Plosser introduced the Neoclassical Model of Capital Accumulation for the use of studying real business cycle. The paper discussed the model focusing on the impact of technological shock. The model is based on the capital stock is accumulated. The technology shock could provide a rational choice of the agents in the economy which can affecting the economy overtime.

The capital accumulation model is a simple model which has only a few main variables. The main variables included output, current consumption, investment, work hours and leisure. The model has assumed that many individual are identical and exited permanently. The mathematical representation of the agents’ utility is [pic] where consumption and leisure are the variables of the utility function. The agents are maximizing their utility and live forever. Work hours and capital are the variables of calculating the production function. The equation of the production function is [pic]. Since the capital K can be depreciated, the capital stock is describe by [pic], where [pic] is the percentage of depreciated assets.

The neoclassical model is under two budget constraint. Firstly, the sum of consumption and investment is equal to the output. Secondly, there is a particular length of time that can be spent as either work hours or leisure. The model also assumed that the agents in the economy can change the level of consumption and level or the length of work hours and leisure freely.

The real business cycle model is initialed by technological shock or change in productivity. While other shock such as money, government spending and tax could have an impact on the model, the author focus mainly on technological shock in the paper. The paper stated that, a growth in technology first increase the productivity per capita. Assuming the...
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