Question

In: Economics

Suppose that in 2011, potential GDP for BloomJack Island is $85,000, real GDP is $75,000, and...

Suppose that in 2011, potential GDP for BloomJack Island is $85,000, real GDP is $75,000, and potential GDP grows at a rate of 2% per year.

  1. If real GDP is $78,000 in 2012, using Okun's law, calculate the cyclical rate of unemployment.
  2. If real GDP is $83,000 in 2013, using Okun's law, calculate the cyclical rate of unemployment.
  3. Sketch a curve to represent Okun’s law, depicting the two points calculated in parts a and b.

Solutions

Expert Solution

Okun's law states that  for every 1% increase in the unemployment rate, a country's GDP will be roughly an additional 2% lower than its potential GDP.

We know cyclical unemployment rate is the difference between potential unemployment rate and current unemployment rate.

1> The difference is real GDP and potential GDP is (85,000-78,000)/85,000 =  0.08235294117

So, the cyclical unemployment rate is 0.08235294117/2 = 0.04117647058 = 4.12%

1> The difference is real GDP and potential GDP is (85,000-83,000)/85,000 =  0.02352941176

So, the cyclical unemployment rate is 0.02352941176/2 = 0.01176470588 = 1.18%

c> Drawing the curve, we got -

Rahul Sunny answered 11 months ago
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