[MUSIC] Let's turn now to how economists measure the costs of unemployment. This is a problem that results not only in a waste of valuable labor resources, but also the loss of potential output. This table provides a calculation of the opportunity cost of the major periods of high unemployment over the last century. This cost is measured as the cumulative difference in potential versus actual output. Not surprisingly, the largest economic loss occurred during the Great Depression, 4.4 trillion between 1930 and 1939. However, the oil and inflation crises of the 1970s and 1980s also generated several trillion additional dollars of lost output. In calculating the numbers, this table indirectly makes use of a very important concept in macroeconomics known as Okun's Law. Okun's Law was first identified by economist Arthur Okun. By studying macroeconomic data, he found an important relationship between output and unemployment, a co-movement, as it were. We can see this relationship in this figure which plots changes in unemployment on the vertical axis and changes in output or GDP on the horizontal axis. The graph shows that unemployment changes are well predicted by the rate of GDP growth. And, according to Okun's Law, for every 2% actual GDP falls relative to potential GDP the unemployment rate rises by about one percentage point. So here's a question. If GDP begins at 100% of its potential and falls to 98% of potential, and if the unemployment rate is initially at 6%, how will that rate change? That's right, according to Okun's Law, the unemployment rate will rise from 6% to 7%. Now, let's try a more interesting example based on actual history. 1979 the employment rate was 5.8%. But over the next three years actual, real GDP didn't grow at all as the economy stagnated. By contrast, potential GDP grew at 3% per year increasing a total of 9% over the three year period. Can you use Okun's Law now to predict the unemployment rate in 1982? Using Okun's Law, we can predict that a 9% shortfall in GDP should have led to a rise of 4.5 percentage points in the unemployment rate. Therefore, starting with an unemployment rate of 5.8% in 1979, Okun's Law would predict a 10.3% unemployment rate by 1982. In fact, the actual rate was very close, 9.7%. One important consequence of Okun's Law is that actual GDP must grow as rapidly as potential GDP just to keep the unemployment rate from rising. In a sense, as our population grows and technology changes, GDP has to keep growing just to keep unemployment in the same place. Moreover, if you want to bring the unemployment rate down, actual GDP must be growing faster than potential GDP.
