Answer to Question #227372 in Economics for Navodya

Question

The relationship between the change of real output and the unemployment rate in the US economy was examined by Arthur M. Okun (1928-1980). How was the theory of business cycle placing an important position in his work? Elaborate.

Answer 1

The natural level of unemployment makes it possible to determine the potential GNP, that is, the volume of the gross national product that can be produced under the conditions of the natural level of employment. The actual level of GNP is usually below its potential level, and the actual level of unemployment is higher than the natural level of unemployment. In these conditions, it becomes necessary to determine what part of the GNP the society receives less due to the excess of the natural level of unemployment. The American economist Arthur Oaken (1928-1980) formulated a law according to which there is an inverse relationship between the unemployment rate and the real volume of GNP, showing that a reduction in unemployment by one percentage point gives an additional increase in real GNP by about 2%. Accordingly, an excess of the actual level of unemployment by 1% of its natural level leads to a lag in the volume of the actual GNP in comparison with the potential GNP by 2%. This is Okun's Law, and 2.0 is Okun's coefficient. So, if the natural unemployment rate in a given year is 4%, and its actual level is 7%, then the difference will be 3%. This 3% must be multiplied by Okun's coefficient (3% 2.0 = 6%).