Suppose the natural rate of unemployment is 35 and the curre

Suppose the natural rate of unemployment is 3.5% and the current unemployment rate is 6%. If potential GDp is $ 8,000 billion how much output is being lost as a result of the economy being below potential. OA s 8400 bllion B s 7800 bllion OC s 7600 billion D $ 8.200 bin

Solution

To estimate the lost GDP due to the economy being below its potential, first the GDP gap is calculated.

To calculate the GDP gap we use the Okun\'s Law.

According to Okun\'s Law, GDP gap = (Current Unemployment - Natural rate of unemployment) x -2

GDP gap = (6 - 3.5) x -2 = -5%

A GDP gap of -5% => $8,000 x 0.05 = $400 billion deficit

That is, the economy could have earned $8000 + $400 = $8400 billion but it is losing $400 billion as a result of excess unemployment.

Therefore, Output lost as a result of economy being below potential = $8400

Correct answer option A. $8400 billion