An economy is projected to grow in real terms by around 1.5 per cent over the next year. It is also predicted that real GDP per employed person will grow by 1.1 per cent over the same period and that average weekly hours worked will remain more or less constant. Which of the following labour force growth rates would provide the basis for an expectation that the unemployment rate will be lower at the end of the year than at the beginning?
Answer: 0.3 per cent
The answer is Option (c) 0.3 per cent.
The facts were:
The late Arthur Okun is famous (among other things) for estimating the relationship that links the percentage deviation in real GDP growth from potential to the percentage change in the unemployment rate - the so-called Okun's Law.
The algebra underlying this law can be manipulated to estimate the evolution of the unemployment rate based on real output forecasts.
From Okun, we can relate the major output and labour-force aggregates to form expectations about changes in the aggregate unemployment rate based on output growth rates. A series of accounting identities underpins Okun's Law and helps us, in part, to understand why unemployment rates have risen.
Take the following output accounting statement:
(1) Y = LP*(1-UR)LH
where Y is real GDP, LP is labour productivity in persons (that is, real output per unit of labour), H is the average number of hours worked per period, UR is the aggregate unemployment rate, and L is the labour-force. So (1-UR) is the employment rate, by definition.
Equation (1) just tells us the obvious - that total output produced in a period is equal to total labour input [(1-UR)LH] times the amount of output each unit of labour input produces (LP).
Using some simple calculus you can convert Equation (1) into an approximate dynamic equation expressing percentage growth rates, which in turn, provides a simple benchmark to estimate, for given labour-force and labour productivity growth rates, the increase in output required to achieve a desired unemployment rate.
Accordingly, an approximate rule of thumb emerges - If the unemployment rate is to remain constant, the rate of real output growth must equal the rate of growth in the labour-force plus the growth rate in labour productivity.
It is an approximate relationship because cyclical movements in labour productivity (changes in hoarding) and the labour-force participation rates can modify the relationships in the short-run. But it provides reasonable estimates of what happens when real output changes.
The sum of labour force and productivity growth rates is referred to as the required real GDP growth rate - required to keep the unemployment rate constant.
Remember that labour productivity growth (real GDP per person employed) reduces the need for labour for a given real GDP growth rate while labour force growth adds workers that have to be accommodated for by the real GDP growth (for a given productivity growth rate).
So in the example, the required real GDP growth rate is 1.5 per cent which means that the sum of labour productivity growth and labour force growth has to be less than 1. 5 per cent over the next year for the unemployment rate to fall.
So the correct answer is that if the labour force grew by 0.3 per cent in the year, there would be a small decrease in the unemployment rate over the course of that year.
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