Final answer:
Okun's Law connects cyclical unemployment with the negative output gap, indicating that as unemployment increases beyond the natural rate, the economy's output falls below its potential, creating a recessionary gap.
Step-by-step explanation:
The proposition that 'each extra percentage point of cyclical unemployment is associated with about a 2 percent widening of a negative output gap, measured in relation to potential output' is known as Okun's Law. Okun's Law highlights the relationship between unemployment and economic growth. Specifically, it suggests that when cyclical unemployment rises, it implies the economy is producing below its potential output, leading to what is known as a recessionary gap.
This gap reflects the distance between the economy's actual output and its potential GDP. When an economy experiences cyclical unemployment, this typically indicates a contraction in the business cycle, leading to a recessionary state where firms are less inclined to hire due to the low equilibrium level of real GDP. Consequently, with higher cyclical unemployment, the output produced is below the full employment level, manifesting a recessionary gap. However, when the economy is performing at potential GDP, the cyclical unemployment should theoretically be at zero, to account for natural fluctuations in job matching, referred to as frictional unemployment.