The economy of Alpha operates according to Okun's law.In Alpha,actual GDP equals $520 billion,the natural rate of unemployment is 5%,and the actual rate of unemployment is 3%.What is potential GDP in Alpha?

Question

Quizplus · Accepted Answer

Okun's law states that for every 1% decrease in the actual rate of unemployment below the natural rate, actual GDP increases by 2%. Given that the actual rate of unemployment is 3% and the natural rate of unemployment is 5%, there is a 2% gap. Therefore, actual GDP is 4% higher than potential GDP (2% increase for each 1% decrease in unemployment rate below the natural rate). Thus, potential GDP can be calculated as follows:

Potential GDP = Actual GDP / (1 + (2% x gap))
               = $520 billion / (1 + (2% x 2%))
               = $500 billion

Thus, the best choice is C) $500 billion.

The Economy of Alpha Operates According to Okun's Law