Question

Suppose that the natural rate of unemployment in a particular year is 4 percent and the actual unemployment rate is 7 percent. Instructions: Enter your answers as a whole number. Use Okun's law to determine the size of the GDP gap in percentage-point terms. If potential GDP is $500 billion in that year, how much output is forgone because of cyclical unemployment? $ billion.

A) 3%
B) 9%
C) 12%
D) 18%

Answer 1

Using Okun's law and a 3 percentage point difference between the natural and actual unemployment rates, we calculate a 6% GDP gap. However, this percentage is not reflected in the provided answer options. For potential GDP of $500 billion, the output forgone due to cyclical unemployment would be $30 billion.

Step-by-step explanation:

To answer the question using Okun's law, the natural rate of unemployment is given as 4%, and the actual unemployment rate is at 7%. Okun's law suggests that for every 1% that the actual unemployment rate exceeds the natural rate, a negative GDP gap of approximately 2% occurs. Therefore, with an actual unemployment rate that is 3 percentage points higher than the natural rate (7% - 4% = 3%), the size of the GDP gap would be 3% × 2 = 6%. However, this does not exactly align with the percentages provided directly in the options (A) 3%, (B) 9%, (C) 12%, (D) 18%. Given these options, the closest answer to our calculation would be 6%, but since it's not available, rechecking the application of Okun's law or the options given for consistency is advised.

Furthermore, if the potential GDP is $500 billion, the dollar value of the output forgone can be calculated by applying the GDP gap to the potential GDP. Assuming the GDP gap is 6%, the output forgone would be 0.06 × $500 billion = $30 billion.