Question

according to okuns law, if the unemployment rate goes from 5% to 3%, what will be the effect on the gdp?
a. it will decrease by 1%.
b. it will increase by 7%.
c. it will increase by 1%.
d. it will decrease by 7%.

Explanation:

Okun's law states that a 1% decrease in the unemployment rate is associated with a 2% increase in GDP growth (and also accounts for the natural growth rate). The unemployment rate here decreases by \( 5\% - 3\%= 2\% \). Using the typical Okun's law relationship (where the GDP change is approximately \( 2\times \) the negative change in unemployment rate plus the natural growth, but simplifying for the relationship between unemployment change and GDP change here), a 2% drop in unemployment leads to a \( 2\times2\% + 3\% \)? No, more simply, the standard Okun's law coefficient is that a 1% decrease in unemployment leads to a 2% increase in GDP (above the natural rate, but the question's options fit with the calculation: the unemployment change is 2 percentage points. The formula is \( \Delta GDP= 3\%+ 2\times(-\Delta Unemployment) \) (but if we consider the change relative to the base, or the common approximation that each 1% decrease in unemployment increases GDP by 2 - 3%? Wait, the correct calculation: the unemployment rate decreases by 2 percentage points. Okun's law (simplified) says that for every 1% decrease in unemployment, GDP increases by 2 - 3% (the exact coefficient varies, but a common approximation is 2% increase in GDP for 1% decrease in unemployment, plus the 3% natural growth? No, the basic Okun's law is \( \text{Actual GDP growth}=\text{Potential GDP growth}- 2\times(\text{Unemployment rate change}) \). If potential growth is 3%, and unemployment decreases by 2%, then actual growth is \( 3\% - 2\times(- 2\%)=3\% + 4\% = 7\% \) (the increase relative to the base, or the change in GDP is an increase of 4% from potential? Wait, no, the question is about the effect on GDP (the level or growth). The key is that a 2% drop in unemployment (from 5% to 3%) leads to a GDP increase. The options: the unemployment change is 2%, so using the coefficient of 2 (for each 1% unemployment decrease, GDP increases by 2% above potential, and potential is 3%? Wait, maybe the question uses a simplified Okun's law where the GDP change is \( 3\%+ 2\times(5\% - 3\%) \)? No, the correct answer is that when unemployment decreases by 2 percentage points, GDP increases by approximately \( 2\times2\%+ 3\% \)? No, the standard way: the unemployment rate falls by 2%. Okun's law (the difference version) is \( \Delta Y/Y=- 2\times\Delta u \), where \( \Delta u \) is the change in unemployment rate. So \( \Delta Y/Y=- 2\times(- 2\%) = 4\% \)? But that's not matching. Wait, maybe the question uses a different coefficient. Wait, the options have 7% as an option. Let's re - evaluate: the natural rate of unemployment is around 5% (full employment is around 5% unemployment). So if unemployment is at 5% (full employment), GDP is at potential. When unemployment drops to 3%, which is 2% below full employment. The formula for Okun's law is \( Y - Y^{}=- 2\times(u - u^{}) \), where \( Y^{*} \) is potential GDP, \( u \) is actual unemployment, \( u^{*} \) is natural unemployment. So \( Y - Y^{*}=- 2\times(3\% - 5\%)=- 2\times(- 2\%) = 4\% \). But that's the output gap. But the question is about the effect on GDP. If potential GDP is growing at 3%, and the output gap is 4%, then the actual GDP growth is \( 3\%+ 4\% = 7\% \) (the increase in GDP relative to the base, or the change in GDP is an increase of 7%? Maybe the question is using a simplified approach where the GDP change is \( 3\%+ 2\times(5 - 3) \), so \( 3 + 4 = 7\% \). So the GDP will increase by 7%, which matches option B.

Answer:

B. It will increase by 7%.