KEY EQUATIONS

Y = AF (K, N) (3.1)

The production function indicates how much output, Y, can be produced for given quantities of capital, K, and labor, N, and for a given level of total factor productivity, A.

Full-employment output, Y, is the quantity of output supplied by firms when wages and prices have fully adjusted, and employment equals its equilibrium value, N.

Okun's law states that a 1 percentage point increase in the unemployment rate, u, reduces output, Y, by 2% of the full-employment level of output, Y. When the unemploy­ment rate equals the natural rate of unemployment, u, output equals its full-employment level.

The growth rate form of Okun's law relates the growth rate of output, ∆Y∕Y, to the average growth rate of full-employment output in the United States, 3%, and the change in the unemployment rate, ∆u. According to Eq. (3.6), output grows more slowly than full-employment output when unemployment is rising and more quickly than full-employment output when unemployment is falling. This version of Okun's law is based on the assump­tion that the natural rate of unemployment is constant.

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