1. ( Natural Rate of Unemployment ) What is the relationship between potential o

Question

1.    (Natural Rate of Unemployment) What is the relationship between potential output and the natural rate of unemployment?

        a.    If the economy currently has a frictional unemployment rate of 2 percent, structural unemployment of 2 percent, seasonal unemployment of 0.5 percent, and cyclical unemployment of 2 percent, what is the natural rate of unemployment? Where is the economy operating relative to its potential GDP?

        b.   What happens to the natural rate of unemployment and potential GDP if cyclical unemployment rises to 3 percent with other types of unemployment unchanged from part (a)?

        c.    What happens to the natural rate of unemployment and potential GDP if structural unemployment falls to 1.5 percent with other types of unemployment unchanged from part (a)?

Explanation / Answer

Potential output refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. The natural rate of unemployment represents the hypothetical unemployment rate consistent with aggregate production being at the "long-run" level.

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