Question

Suppose that the natural rate of unemployment in a particular year is 5 percent and the actual rate of unemployment is 9 percent. use okun's law to determine the size of the gdp gap in percentage-point terms. if the potential gdp is $500 billion in that year, how much output is being forgone because of cyclical unemployment?

Answer 1

According to Okun’s law, for every 1 percentage point by which the actual unemployment rate exceeds the natural rate, a negative GDP gap of about 2 percent occurs. The actual unemployment rate exceeds the natural rate by 4 percent. This is calculated as follows :

Actual unemployment – natural unemployment = 9 – 5 = 4%.

Thus, according to Okun’s law the GDP gap is -8%.

If the potential GDP is $ 500 billion, the actual GDP is 8% lower than the potential GDP. In other words, 8% of the $ 500 billion is being forgone because of cyclical unemployment.

GDP forgone = 8% x potential GDP = 8% x 500 = $40 billion