Question

Assume that in a particular year, the natural rate of unemployment is 5 percent and the actual rate of unemployment is 9 percent. Use the Okun’s law to estimate the size of GNP gap in percentage point terms. If the potential GNP is 500 billion in that year, how much output is being foregone because of cyclical unemployment?

Answer 1

$$Solution$$

a. ) The GNP gap is the difference between actual GNP and potential GNP. Okun's law suggests a GNP gap of -2% for every 1% that the unemployment rate exceeds its natural rate. In this case, the GNP gap is (9.0 – 5) x -2 = -8%.

The size of GNP gap in percentage point terms is -8%

b)A GDP gap of -8% implies that $500 x .09 = $45 billion of output is being foregone because of cyclical unemployment.