Suppose the unemployment rate is 7%,the natural rate of unemployment is 5%,and actual GDP is $400 million.According to Okun's Law,what is potential GDP?

Question

Quizplus · Accepted Answer

Okun's Law states that for every 1% increase in the unemployment rate, there is a 2% decrease in GDP.

Thus, the difference between the actual unemployment rate (7%) and the natural rate of unemployment (5%) is 2%. This implies that GDP is 4% below its potential level (since 2% increase in unemployment leads to 4% decrease in GDP according to Okun's Law).

Therefore, potential GDP = actual GDP / (1 - 4%) = $420 million.

Hence, the correct answer is D.

Suppose the Unemployment Rate Is 7%,the Natural Rate of Unemployment