Considering you answer to part (b), what happens to unemployment in the short run and in the long run according to Okun’s law? Again, first describe what should happen and then calculate the precise numerical answer.

According to Okun’s law, the relationship between real GDP and unemployment is negative. Following equation summarizes the Okun’s law:

    The above equation shows that moving direction of output is opposite from unemployment, and the ratio is 2 to 1. Increase in output in short run decreases unemployment. Since it is assumed that velocity of money is constant, the output increases by 7% so unemployment decreases by 3.5 percent. However, in the long run, both unemployment and output returns to the natural, hence the long term change doesn’t exist.