Using Okun's law, if the natural rate of unemployment is 4% and the actual unemployment rate is 9%, the output gap is:[Fill in the blank]

Question

BlackTom AI · Accepted Answer

To tackle this question, start by identifying the key values given: the natural rate of unemployment u* = 4% and the actual unemployment rate u = 9%. The difference between actual and natural reflects the deviation in unemployment: u − u* = 9% − 4% = 5 percentage points.

Next, recall Okun's law in its common simplified form: the output gap (as a percentage of potential output) is approximately proportional to the negative of the unemployment gap. The typical coefficient used in many introductory treatments is about 2, so output gap ≈ −2 × (u − u*).

Applying this standard relationship, substitute the computed unemployment gap: output gap ≈ −2 × 5% = −10%. In words, the economy is producing about 10% below potential output when unemployment is 5 percentage points above the natural rate.

Now evaluate the answer options:
- Option a: (-) 8% would imply a coefficient of 1.6 in this simple form, which is not the common Okun’s law coefficient and thus is not consistent with the typical approximation.
- Option b: (-) 10% matches the calculation using the standard Okun’s coefficient of about 2, given a 5 percentage point unemployment gap.
- Option c: (-) 6% would correspond to a coefficient of 1.2, which is not the conventional Okun’s relation used here.
- Option d: (-)4% would imply a much smaller negative output gap than what Okun’s law signals for a 5-point unemployment deviation.

So, the reasoning leads to the conclusion that the correct estimate, under the standard Okun’s law with a coefficient near 2, is a 10% negative output gap, i.e., option b.

Using Okun's law, if the natural rate of unemployment is 4% and the actual unemployment rate is 9%, the output gap is:[Fill in the blank]

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