Question

Briefly describe the difference between a so-called real business cycle and a more traditional “spending” business cycle.

Short answer

The real business cycles are caused by real factors that affect aggregate supply. At the same time, the traditional spending business cycles are caused by factors that affect aggregate demand.

Step-by-step solution

Explanation

In real-business-cycle theory, business fluctuations result from significant changes in technology and resource availability.Those changes affect productivity and, thus, the long-run growth trend of aggregate supply; for example, the adverse supply shock creates a recession.

On the other hand, the recession created by the reduced purchasing power (that is, reduced aggregate demand) is a part of the traditional spending business cycle; for example, a traditional spending business cycle can be created because of changing income tax structure which affects the disposable income and, therefore, the aggregate demand.