3-4c Okun's Law AP Only

‘Real’ unemployment is the rate of cyclical unemployment, which is the percentage of unemployment above the natural rate of unemployment. At any given time, it is expected that a ‘natural’ percentage of the workforce will be frictionally unemployed due to firings, or people quit, etc. People that are structurally unemployed can be thought of as being part of the ‘natural’ rate because they either have to change careers or drop out of the labor force. So, it is believed that between 4%-6% is the natural rate of unemployment. Real unemployment is what we consider to be due to a downturn in the business cycle. Therefore, one indication of the health of the economy is the unemployment rate.

Now that you understand ‘real’ unemployment, we are going to estimate lost GDP due to unemployment using Okun’s Law. For Okun’s Law, we will use 6% as the natural rate of unemployment. So ‘real’ unemployment is the level above 6%. If the unemployment rate is 8%, then real unemployment is 2%. Okun’s Law states that for every percentage of ‘real’ unemployment there is a 2% reduction in GDP. The formula is as follows:

Real Unemployment x 2 = % GDP Gap
Or, [Actual Unemployment Rate – 6%] x 2 = % GDP Gap

Then, using Okun’s Law you can figure out how much dollar GDP is being foregone due to unemployment. For example, if GDP is 100 and Unemployment is 8%, then the GDP gap is 4%, and output foregone is 4 and potential GDP is 104.


Answer the questions that follow using Okun's Law.

In your answers, do not use commas to delineate the thousands place or millions place in numbers.

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