Question

The following are selected statistics for a given year in a hypothetical economy Nominal GDP $500 billion Natural rate of unemployment 8% Actual rate of unemployment 10% GDP deflator 115 Refer to the information above to answer this question. What is the amount of the GDP gap? Select one: a. $25 billion. O b. $525 billion. O c. $20 billion. O d. $475 billion. O e. $435 billion.

Answer 1

GDP gap is the difference between : Optimum GDP at natural rate of unemployment , &  actual GDP (at actual unemployment rate).

Higher the difference between natural & actual rate of unemployment, means higher GDP gap of actual GDP below full optimum GDP.

Okun's Law states that : for each 1% percent gap between natural unemployment rate & actual unemployment rate, twice GDP gap of 2% below optimum potential GDP occurs.

This actual rate of unemployment (10%), ie higher than natural rate of unemployment (8%), by a margin of 2%. ​​​​​​So, GDP gap would be 2 x 2 ie 4%.

Let optimum potential GDP be = Y. Optimum potential GDP - 4% of (Optimum potential GDP) = Actual GDP

Y - 4%Y = 500 → 96% Y = 500 → Y = 500 x 100 / 96 = 520

Y (optimum potential GDP) = 520.

So, GDP GAP = Optimum potential GDP - Actual GDP (nominal GDP) = 520 - 500 = 20