State Okun's law and describe the relationship between the output gap and unemployment.

• A. Positive relationship; higher output increases unemployment.
• B. No relationship between output and unemployment.
• C. Unemployment drives GDP growth directly.
• D. Negative relationship; when actual output is below potential unemployment tends to be higher; when output exceeds potential unemployment tends to be lower.

Answer: (D)

Okun's law describes a link between the unemployment rate and how far actual output is from what the economy could sustainably produce. The key idea is that these two move in opposite directions. The output gap is the difference between actual output and potential output (the level the economy can produce with full employment). When actual output is below potential, the economy has a negative output gap, and unemployment tends to be higher because weaker demand means firms hire fewer workers. When actual output is above potential, the economy has a positive output gap, and unemployment tends to be lower as stronger demand leads to more hiring. This is an empirical pattern, not a precise rule, and the exact strength can vary, but the sign of the relationship is consistently negative.