Consider an economy that initially has a labor force of 2000 workers. Of these workers, 1500 are...
Question:
Consider an economy that initially has a labor force of 2000 workers. Of these workers, 1500 are employed.
The economy enters a recession. Employment falls by 5%. Another 0.4% of the labor force becomes discouraged at the prospect of finding a job and leaves the labor force.
a) Calculate the unemployment rate before and after the recession.
b) Using Okun's law, calculate the expected percentage change in real GDP.
Unemployment Rate:
Unemployment rate is an important indicator of the state of the economy. It is calculated as the number of unemployed workers divided by the size of the labor force. An important point is that workers have to be in the labor force to be recognized as unemployed, i.e., workers who stopped looking for jobs are considered not in the labor force and not part of the unemployed.
Answer and Explanation: 1
a) Before recession, unemployment rate = number of unemployed / labor force = (labor force - number of employed) / labor force = (2000 - 1500)/2000 = 25%.
After recession, the labor force = 2000*(1 - 0.4%) = 1992. Number of workers employed = 1500*(1 - 5%) = 1425. Number of people unemployed = 1992 - 1425 = 567. Unemployment rate = 567/1992 = 28.46%.
b) Real GDP will decrease by 6.92%.
The Okun's Law states that for every 1 percent increase in unemployment, real GDP decreases by approximately 2 percent.
After the recession unemployment rate increases by 28.46% - 25% = 3.46%. Real GDP will decrease by 2*3.46% = 6.92%.
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