In Okunland, a country that operates according to Okun's law, real GDP equals $7,520 billion, potential GDP equals $8,000 billion, and the actual unemployment rate is 8 percent. What is the natural rate of unemployment in Okunland?

Question

Quizplus · Accepted Answer

According to Okun's law, for every 1 percent decrease in the actual unemployment rate, there will be a 2 percent increase in real GDP above potential GDP.

So, we can calculate the output gap as follows: 
Output gap = ((Real GDP - Potential GDP) / Potential GDP) x 100 
Output gap = ((7,520 - 8,000) / 8,000) x 100 
Output gap = -5.93%

To achieve potential GDP, the output gap needs to be zero. So, we need a 5.93% increase in real GDP, which implies a decrease in the actual unemployment rate by 2 x 5.93 = 11.86 percentage points.

Therefore, the natural rate of unemployment in Okunland is 8% + 11.86% = 19.86%. However, this is not one of the answer choices. The question asks for the best choice, which is B, as it is the closest to the natural rate of unemployment (which is unknown) and provides a reasonable estimate based on the information given.

In Okunland, a Country That Operates According to Okun's Law