Relative Demand Shocks

University of Aarhus Economics Working Paper No. 2004-11

39 Pages Posted: 4 Nov 2004

See all articles by Francesco Busato

Francesco Busato

Aarhus University - School of Business and Social Sciences

Multiple version iconThere are 2 versions of this paper

Date Written: May 19, 2004


This paper introduces the concept of relative demand shocks into a multi-sector dynamic general equilibrium model. Relative demand shocks change the instantaneous structure of preferences. Under relative demand shocks consumer tastes randomly shift across different commodities, as manifested by unexpected relative increases or decreases in the marginal utility of the various consumption goods. There are no exogenous technology (productivity) shocks in the model. There are three main results. First, the model proposes an original theoretical mechanism for generating aggregate fluctuations and sectoral comovement by using inter-sectoral and idiosyncratic shocks. This mechanism is complementary to the standard Real Business Cycle theory. Second, the model is effectively able to reproduce the main stylized facts of the U.S. economy, also those that the standard Real Business Cycle model fails to explain. Third, the model generates a false Solow Residual, even though there is no technological progress in the model. Its size and time series properties are analogous to the actual Solow Residual.

Keywords: Demand Shocks, Two-sector Dynamic General Equilibrium Models

JEL Classification: F11, E32

Suggested Citation

Busato, Francesco, Relative Demand Shocks (May 19, 2004). University of Aarhus Economics Working Paper No. 2004-11, Available at SSRN: or

Francesco Busato (Contact Author)

Aarhus University - School of Business and Social Sciences ( email )

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