Question

Suppose one economist believes that the target rate of unemployment is 4 percent while another believes that it is 6 percent. If GDP is $5 trillion and the unemployment rate is 6 percent, then Okun's rule of thumb implies that the target output levels for these two economists will differ by:

A. $100 billion.
B. $200 billion.
C. $300 billion.
D. $400 billion.

Answer 1

Using Okun's rule of thumb, the difference in target output levels for the two economists with different target unemployment rates is $200 billion, which is 4% of the given $5 trillion GDP. The correct option is B.

Step-by-step explanation:

The question asks to calculate the difference in target output levels for two economists with different target rates of unemployment using Okun's rule of thumb. With a given GDP of $5 trillion and an actual unemployment rate of 6%, and considering Okun's rule of thumb typically suggests that every 1% increase in the unemployment rate above the natural rate is associated with a 2% decrease in actual GDP from its potential level, we must find the output gap for the 4% and 6% target rates respectively.

For the first economist with a 4% target rate, the unemployment rate is 2% higher than the target (6% - 4% = 2%). According to Okun's rule, this implies a GDP gap of 4% (2 x 2% = 4%). Similarly, for the second economist with a 6% target, there is effectively no gap as the actual rate matches the target. Therefore, to find the difference in target output levels, we calculate 4% of $5 trillion, which equals $200 billion.

The target output levels for these two economists will differ by $200 billion.