Question

20)

Suppose that the natural rate of unemployment in a particular year is 6 percent and the actual rate of unemployment is 11 percent. Instructions: Enter your answers as whole numbers. a. Use Okun’s law to determine the size of the GDP gap in percentage-point terms. b. If the potential GDP is $500 billion in that year, how much output is being forgone because of cyclical unemployment?

Answer 1

Answer (a) : GDP gap in percentage-point terms = 10%

Answer (b) : $50 billion.

Solution & Explanation :-

Answer (a) : The actual rate of unemployment exceeds the natural rate of unemployment by :

11% - 6% = 5% which is cylindrical unemployment.

Now, Okun's Law states that a negative gdp gap of about 2 percent occurs, for every 1 percentage point by which the actual unemployment rate exceeds the natural rate.

So, using Okun's Law,

GDP gap in percentage points term is :

2 × 5% = 10%

Answer (b) : Since we are 10% below the amount of potential GDP which is $500 billion.

then, the output foregone because of cyclical unemployment is :

= 10/100 × $500 billion

= $50 billion.