Question

Following table are the data for the Australian economy (?=1.6) in four selected years. Using Okun’s law, fill in the missing data in the table.

Year

Actual Unemployment

Rate (%)

Natural Unemployment

Rate (%)

Potential

GDP

Real GDP

2001

(a)

5

8000

7872

2002

5

(b)

8100

8100

2003

4

4.5

(c)

8266

2004

4

5

8250

(d)

Answer 1

Okun's Law states that each extra percentage point of cyclical unemployment us associated with 2 percentage point increase in output gap and cyclical unemployment refers to the extra unemployment that occurs during recession.

a) In 2001, Real GDP is 8000-7872/8000 = 1.6% below potential GDP so cyclical unemployment 0.8%

Since Natural unemployment is 5%,the actual unemployment rate must be 5%+0.8% = 5.8%

b) In 2002, the potential output equals 8100 which is same as real GDP so the cyclical unemployment is equal to zero.

Therefore,the Natural unemployment rate must be equal to actual unemployment rate = 5%

c)In,2003, cyclical unemployment equals U-U* = 4%-4.5% = -0.5%

By Okun's Law the output gap Y*-Y is =1%

This implies that real GDP is 1% larger than the potential GDP,so

Potential GDP is equal to 8184.2

d)Since natural unemployment is 1% more than the actual unemployment therefore the output gap must be -2%

Real GDP should be 2% above potential GDP

Therefore Real GDP = 8250+165 = 8415