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Economics 121

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Part A. Unemployment, Okun’s Law, and the GDP Gap (three points) 1. (two points) The US unemployment rate (actual unemployment, u) is 3.6 percent, while the natural rate of unemployment (nru) is 4.6 percent. a. (i) Is the economy in an expansion, a contraction, or neither? (ii) Where is potential (full-employment) output (Qf) compared to the “trend line”—on it, above it, or below it? (iii) Where is actual output (Q) compared to the trend line—on it, above it, or below it? (iv) Therefore: is Q equal to, greater than, or less than Qf? Explain your answer. [Reminder: output = real GDP] b. (i) How much of the (actual) unemployment is frictional and structural together? (ii) How much is cyclical? Explain your answer. c. (i) Define the percentage GDP gap in general. (ii) State mathematically the “Okun formula” (Okun’s Law) for estimating the percentage GDP gap. (iii) State Okun’s Law in words. d. (i) Using Okun’s Law, compute the US current percentage GDP gap. Show your computation. (ii) State your answer in words, comparing actual to potential output. (iii) Is the US GDP gap positive or negative—and why? 2. (one point) In 2008, the unemployment rate (u) was nine percent, and the natural rate of unemployment (nru) was six percent. (i) Again using Okun’s Law, what was the percentage GDP gap then? Show your computation. (ii) State your answer in words, comparing actual to potential output. (iii) What is the sign of the GDP gap then? (iv) Why is the sign of the GDP gap in 2008 the opposite of the sign of the current GDP gap? Explain. Part B. Inflation and Real GDP (two points) 3. In a hypothetical economy, the GDP deflator has the following values. Year GDP Deflator 2005 100 2018 116 2019 120 a. What is the annual inflation rate in 2019? Show your computation. [Hint: Round your answer to two decimal places.] b. Nominal GDP in 2019 is $420 billion. What is real GDP (billions of 2005 dollars) in 2019? Show your computation. [Hint 1: Think level, not percentage change.] [Hint 2: This question refers to an earlier part of the course.]

 
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