Question

A country’s current unemployment rate is 11 percent. Economists estimate that its natural rate of unemployment is 6 percent. About how large is this economy’s negative GDP gap?

1. 1 percent

2. 3 percent

3. 6 percent

4. 10 percent

Short answer

Option (d) 10 percent

Step-by-step solution

Relationship between GDP gap and the unemployment rate

According to Okun’s unemployment theory, the relationship between actual unemployment and the GDP gap is given as:

$GDPgap=-2\times \left(actualunemploymentrate-naturalrateofunemployment\right)$

Therefore, the GDP gap has an inverse relation with the difference between the actual unemployment rate and the natural rate of unemployment.

Calculations for estimating the value of negative GDP gap

It is given that the actual unemployment rate is 11% and the natural rate of unemployment is 6%. Therefore, the GDP gap is:

$$\begin{gathered} GDPgap=-2\times \left(11-6\right)\% \\ =-10\% \end{gathered}$$

Therefore, the negative GDP gap is 10%.