Chapter 13: Business Cycles and Economic Growth

The ultimate goal of macroeconomics is to overcome recessions and achieve sustainable growth. This chapter studies short-term fluctuations (business cycles) and long-term trends (economic growth).

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1. Business Cycle

A phenomenon where real GDP periodically rises and falls around potential GDP.

• Phases: Recovery $\rightarrow$ Expansion (Peak) $\rightarrow$ Contraction $\rightarrow$ Recession (Trough).
• Causes:
  • New Keynesian School: Variations in aggregate demand and price rigidity are the causes.
  • Real Business Cycle (RBC) Theory: Real shocks, such as technological shocks or sudden changes in oil prices, are the causes.

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2. Economic Growth Theory

A long-term phenomenon where the production possibilities frontier itself shifts outward.

(1) Solow Growth Model

• Capital Accumulation: Increasing capital through savings increases production, but since the marginal product of capital is diminishing, capital alone cannot lead to infinite growth.
• Steady State: A state where investment in capital equals the depreciation of capital, so that capital and output per worker no longer change.
• Role of Saving Rate: A higher saving rate increases the level of income per worker in the long run, but it does not permanently increase the long-run growth rate.
• Technological Progress: The only source of sustained growth in income per worker in the long run is technological progress.

(2) Convergence Hypothesis

• A hypothesis that, given similar technology levels, poorer countries with lower initial capital will grow faster than richer countries and eventually catch up.

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3. Endogenous Growth Theory

• Unlike the Solow model, which treats technological progress as an external variable, this theory sees technological progress and human capital investment as determined by choices within the economy (Education, R&D).

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Key Checklist

• In the Solow model, what is the key factor driving actual growth in income per worker? (Answer: Technological Progress)
• Does raising the saving rate permanently increase the long-run economic growth rate? (Answer: No, only the level of income increases)
• What does Real Business Cycle (RBC) theory see as the cause of business cycles? (Answer: Real shocks like technological shifts)
• What do we call the phenomenon where poor countries catch up with rich countries? (Answer: Convergence Hypothesis)