[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

12
10
UNEMPLOYMENT RATE (%)
8
6
4
2
0
–9 –8 –7 –6 –5 –4 –3 –2 –1 0 1 2 3 4 5 6 7 8 9
OUTPUT GAP (%)
Figure 22.4
OKUN’S LAW, 1959–2002
Okun’s Law relates fluctuations in output relative to potential (the output gap) and fluctuations
in the unemployment rate. For every 1 percentage point change in the unemployment
rate, the output gap changes approximately 2 percentage points.
Figure 22.4 shows that when the output gap is zero, so that real GDP equals
potential GDP, the unemployment rate in the United States is usually around 5.5
percent. If real GDP falls below potential GDP and the output gap becomes negative,
then unemployment rises above 5.5 percent. This makes sense—when the
output gap is zero, the unemployment rate should be equal to the natural rate of
unemployment, which, as we have already noted, is usually estimated to be about
5.5 percent.
Okun’s Law provides an easy way to link fluctuations in unemployment with fluctuations
in the output gap. It can also help us estimate the cost of a recession. In the
boom year of 1999, the number of unemployed Americans fell below 6 million. By
2002, just over 8 million American workers were seeking work but unable to find
it. From the standpoint of the economy, the loss from an increase in unemployment
during a recession is the output that could have been produced if those workers had
remained employed. This lost output represents the opportunity cost of the higher
unemployment, and we can use Okun’s Law to roughly calculate it. Unemployment
reached 5.8 percent in 2002. Using an estimate of 5.5 percent for the natural rate, we
find that cyclical unemployment was 5.8 minus 5.5 percent, or 0.3 percent. According
to Okun’s Law, that would be associated with a 2 × 0.3 = 0.6 percent negative output
gap. With real GDP in 2002 equal to roughly $10 trillion, a 0.6 percent output gap
means the economy was producing 0.6 percent of $10 trillion, or $60 billion
($60,000,000,000), less per year than its potential. This is the opportunity cost of the
rise in unemployment during the recession, an amount equal to just under $200 per
person in the United States.
504 ∂ CHAPTER 22 MEASURING OUTPUT AND UNEMPLOYMENT