Law in business (Okun's law)

1. Okun’s Law: Output and Unemployment
By
Dr. Paul Onyina

2.  How much output is forgone with cyclical
unemployment? This is the basic question answered by
Okun’s ‘Law’
Okun’s Law:
◦ Each extra percentage (1%) point in unemployment is
associated with some (%) increase in the output gap (or some
change in (Y) actual output.
◦ The size of this relationship is estimated by economists. It is
based on this relationship over time in a particular country.
◦ The size of this response gives us some information about the
responsiveness of output to changes in cyclical unemployment.

3.  For the United States this relationship has
been calculated using real GDP and
unemployment data. It has been found that
an unemployment rate which is 1% above the
natural rate of unemployment (u*) will cause
Y to fall below potential by 2%
 However, for Ghana, unemployment rate is
above the natural rate of unemployment (u*),
this causes Y to fall below potential.

4. In symbols:
= –β (u – u*)
- where y is the actual output and y* is the full-
employment level of output
- where β is 2 for the US.
- β varies based on the country.
*
*
y
yy 

5. Example: June 1983 (Currency in US$)
Ghana u = 10.3%, u* = 8.08%,
y* = $108 213.6 million, if –β (u – u*).
then (let B= 1.5)
–β (u – u*) = –1.5 (0.103 – 0.0808) = –0.0333
Therefore, the output gap was –3.33% of y*
= 3.33% x $108 213.6 million
= $3603.51 million
This is a recessionary gap (negative sign).