Question

The potential GDP and actual GDP of an economy are $25000 and $20000 respectively. What is the GDP gap? If the natural rate of unemployment is 5%, what is the actual rate of unemployment?

Answer 1

$\bold {Answers}$

GDP gap = $5,000 or 20%

Actual unemployment rate = 15%

$\bold {Solutions}$

GDP Gap $=$ Potential GDP - Actual GDP

$= Y^* - Y$

$= \$25,000 - \$20,000$

$\bold {= \$5,000}$

GDP gap as a percentage of potential GDP $= \dfrac {Y^* - Y}{Y^*} × 100\%$

$= \dfrac {\$5,000}{\$25,000} × 100\%$

$\bold {= 20\%}$

According to Okun's Law, the relationship between output gap and unemployment rate is given by:

$\dfrac {Y^* - Y}{Y^*} = 2(u - u^*)$ where $u^*$ Is the natural rate of unemployment and $u$ is the actual unemployment rare.

It is given that $u^* = 0.05$

Therefore,

$0.20 = 2(u - 0.05)$

Dividing by 2 both sides gives:

$0.10 = u - 0.05$

$=> u = 0.10 + 0.05$

$=> \bold {u = 0.15}$

Thus, the actual rate of unemployment, according to Okun's law is 15%.