Question

Suppose that the natural rate of unemployment in a particular year is 4 percent and the actual unemployment rate is 13 percent. Instructions: Enter your answers as a whole number. a. Use Okun's law to determine the size of the GDP gap in percentage-point terms. percent b. If potential GDP is $500 billion in that year, how much output is forgone because of cyclical unemployment? $ billion

Answer 1

a. 18 percent

b. $90 billion

Explanation:

a. Calculation to use Okun's law to determine the size of the GDP gap in percentage-point terms.

First step is to find the difference between ACTUAL RATE of unemployment and NATURAL RATE of unemployment

Difference=13%-4%

Difference= 9%

Based on the information above calculation we can see that the ACTUAL RATE of unemployment EXCEEDS the NATURAL RATE of unemployment by 9%, which indicates a CYCLICAL UNEMPLOYMENT.

Thus, According to Okun's law, this translates into an 18 % GDP gap in percentage-point terms (= 2 × 9%).

Therefore the the size of the GDP gap in percentage-point terms is 18 percent

b. Calculation to determine how much output is forgone because of cyclical unemployment

Forgone Output :

By applying Okun’s law we known that the GDP gap is 18%, which means that we are 18% below the GDP amount which is given as $500 billion,

Hence,

Output forgone = (18/100) ×$500 billion

Output forgone=0.18×$500 billion

Output forgone=$90 billion

Therefore the Forgone Output is $90 billion