GDP Gap and Okun's Law
GDP gap is one of the consequences of unemployment and the other one is social costs. Social costs: Increase in crime rate ( violence,theft, and destruction of property), increase number of suicides and increase in health problems ( heart disease, mental illness and stress). Economic cost: GDP gap(output gap)
A GDP Gap is the difference between potential GDP(total amount that an economy is capable of producing when all resources are used) and Actual GDP ( the value of all final goods and services produced).
Recessionary gap -actual GDP<Potential GDP( down side high unemployment) expansionary gap- actual GDP > Potential GDP(down side inflation)
At potential GDP there is no cyclical unemployment
You can estimate the size of a gap by seeing how much cyclical unemployment there is. Okun's Law states that the economy is in its natural rate of unemployment, when all resources are utilized and there is no cyclical unemployment; and for every 1% of cyclical unemployment, the size of the GDP gap increases 2.5%.
GDP gap= potential GDP-Actual GDP
GDP Gap=2.5*cyclical unemployment * actual GDP
If there is cyclical unemployment then it is a recessionary gap but if there is no cyclical unemployment if it is an expansionary gap.
% of potential GDP lost due to unemployment= GDP gap/potential GDP*100
when all resources are used there will be no cyclical unemployment and the economy is at the natural rate of unemployment
Dr. Stephanie Powers, "Unemployment", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)
GDP gap is one of the consequences of unemployment and the other one is social costs.
Social costs: Increase in crime rate ( violence,theft, and destruction of property), increase number of suicides and increase in health problems ( heart disease, mental illness and stress).
Economic cost: GDP gap(output gap)
A GDP Gap is the difference between potential GDP(total amount that an economy is capable of producing when all resources are used) and Actual GDP ( the value of all final goods and services produced).
Recessionary gap -actual GDP<Potential GDP( down side high unemployment)
expansionary gap- actual GDP > Potential GDP(down side inflation)
At potential GDP there is no cyclical unemployment
You can estimate the size of a gap by seeing how much cyclical unemployment there is.
Okun's Law
states that the economy is in its natural rate of unemployment, when all resources are utilized and there is no cyclical unemployment; and for every 1% of cyclical unemployment, the size of the GDP gap increases 2.5%.
GDP gap= potential GDP-Actual GDP
GDP Gap=2.5*cyclical unemployment * actual GDP
If there is cyclical unemployment then it is a recessionary gap but if there is no cyclical unemployment if it is an expansionary gap.
% of potential GDP lost due to unemployment= GDP gap/potential GDP*100
when all resources are used there will be no cyclical unemployment and the economy is at the natural rate of unemployment
Dr. Stephanie Powers, "Unemployment", Intro to Macroeconomics.(Lecture, Donald School of Business, Red Deer Alberta, Winter 2012)