Using the real business cycle theory, explain the effects of an adverse technological shock on the labor market and on the output market. Illustrate graphically how the adverse technology shock affects labor demand and supply

Why is this theory controversial?

The real business cycle theory emphasizes that changes in technology will usually change the level of full employment and output. An adverse technological shock would cause output and potential output to fall and would cause a decrease in the demand for labor. Critics of the theory find it difficult to explain how many of the post-World War II recessions can be explained by adverse technological shocks. Critics also point to the fact that the theory does not provide an explanation for unemployment, because in the real business cycle model, the labor market is in equilibrium: the quantity of labor demanded equals the quantity of labor supplied, and everyone who seeks employment finds employment.