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What Is the Relationship between GDP and Unemployment Rates?

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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 26 November 2016
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The relationship between Gross Domestic Product (GDP) and unemployment rates can be seen by the application of Okun’s Law. According to the principles established by this law, there is a corresponding two percent increase in employment for every established one percent increase in GDP. The reasoning behind this law is quite simple. It states that GDP levels are driven by the principles of demand and supply, and as such, an increase in demand leads to an increase in GDP. Such an increase in demand must be accompanied by a corresponding increase in productivity and employment to keep up with the demand.

GDP and unemployment rates are linked in the sense that both are macroeconomic factors that are used to gauge the state of an economy. A rise in the GDP is significant in the study of macroeconomic trends in a nation. This is also true of a rise or decrease in unemployment levels. GDP and unemployment rates usually go together because a decrease in the GDP is reflected in a decrease in the rate of employment.

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Such a relationship between GDP and unemployment rates is important in two ways. A rise in employment levels is the natural result of increased GDP levels caused by an increase in consumer demand for goods and services. Such a rise in both GDP and employment levels is an indication that the economy is booming. During such periods, consumer confidence is high and the demand for various goods and services are correspondingly elevated. In order to meet this surge in demand, manufactures and other types of companies hire more employees.

The opposite is true in the case of a deflation, which also shows the relationship between GDP and unemployment rates. When there is a dip in the GDP caused by a decrease in consumer confidence and a corresponding reduction in demand, companies must adjust to this low demand. Part of the adjustment process includes the shedding of workers who may have become redundant in the face of sluggish demand by consumers.

At times like this, companies look for ways of conserving money since they are no longer making as much money as they used too. One of the cost-cutting measures includes mass sacking of employees whose salaries the companies can no longer sustain. Signs like this are indicators to economists that the demand for goods and services have dropped and that the GDP level is also on a downward slope.

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SarahGen
Post 4

@turkay1-- That's because it takes time for companies to hire new employees.

If national GDP goes up, resulting an increase in demand, companies will have to produce more goods to fulfill that demand. But this doesn't mean that companies immediately hire new employees.

First, they will give their current employees more hours to increase production. If demand continues to rise to the extent that current number of employees cannot fulfill production, then new hires will be made.

This is why it takes a 2% increase in national GDP for employment rates to go up by 1%.

candyquilt
Post 3

Why does it take a 2% increase in employment for GDP to go up by 1%? Shouldn't it be 1% to 1%?

bluedolphin
Post 2

@anon288127-- I don't think that unemployment directly leads to a fall in GDP. I think there is usually a third factor that causes a change in both of these.

For example, if the economy isn't doing well and this leads to companies going bankrupt, then this will have a negative effect on both national GDP and employment rates. As businesses go out of business, people will lose their jobs. The decrease in production and profits will also result in a decrease in GDP.

anon288127
Post 1

What is it that leads to a fall in GDP as a result of an increase in unemployment?

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