Question

Okun’s Law is written as u – u(-1) = -0.4 (g_Y – 3%)

a. What is the sign of u – u(-1) in a recession? What is the sign of u – u(-1) in a recovery?

b. Explain where the 3% number comes from?

c. Explain why the coefficient on the term (g_Y – 3%) is -0.4 and not -1.

d. Suppose the number of immigrants per year allowed to enter the United States is sharply increased. How would Okun’s law change?

2. Use the IS-LM-PC model to illustrate how the economy adjusts to an increase in taxes both in the short run and in the medium run.

3. Explain why in the medium run an increase in the price of oil will cause an increase in the unemployment rate.

4. If the economy is initially operating at the natural level of output why an increase in the price of oil will cause an increase in the aggregate price level.

5. Explain why during the short run, an increase in the price of oil will cause an increase in the interest rate.

Answer 1

Answer:

Given that:

Okun's Law is written as u-u(-1)=-0.4(gy-3%)

okum 's law depicts the relationship the change in unemployment and the rate of growth of output.

a)

According to the equation of Okm 's ,u-u(-1) depicts cyclical unemployment in the country .Cyclical unemployment is related to the business cycles in an economy.

In the case of recession ,the cyclical unemployment is more.This is because the unemployment in current period is higher than that in previous period .

Therefore, u-u(-1) will have a positive sign in recession.

During recovery ,the cyclical unemployment has reduced as the economy is on the road of recovery and unemployment in current period is lesser than that in previous period.

Therefore, u-u(-1) will have a negative sign in recession.

b)

The 3% in Okm's law is the natural rate of growth in output . Several studies that have been conducted the U.S data from 1960s onwards have found that a 3% growth rate of output will be to keep unemployment constant .

c)

The -0.4 in the equation is the Okm's coefficient .Okm's coefficient is the value which links the unemployment changes to the changes in output .

It gives away the proportion by which unemployment changes fails by the very same proportion.

There will always be a mismatch between the change in output and the change in unemployment.

Okm's coefficient of -0.4 means that when output changes by 1% ,unemployment changes by 0.4 in the opposite direction.

d)

With the advert of immigrants ,the natural rate of unemployment will change.This will also lead to changes in the output gap.