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The fact that both real GDP and employment decline during recessions and increase during expansions, coupled with the fact that real GDP fluctuates more than employment, gives rise to an empirical relationship known as Okun's Law. It is named after economist Arthur Okun. Okun's Law states that the unemployment rate decreases about one percentage point for every 3 percent increase in real GDP. Although the relationship between unemployment and real GDP is complicated and the precise numerical relationship noted by Okun's Law is not completely accurate, the law does point out that a given percentage change in real GDP will correspond to a smaller percentage change in unemployment. Why does the number of jobs in the economy not increase at the same rate as output? One reason is that, when the economy expands, firms may increase the number of hours of their current employees rather than hire new ones. In addition, if firms are carrying excess labor at the beginning of an expansion, they will put this excess labor to work before hiring new workers. Another reason is the discouraged worker effect. Recall that the unemployment rate does not include discouraged workers who are not actively looking for work. During an expansion, many of these discouraged workers begin looking for work and, as a result, are counted in the labor force. Because they are in the labor force but not yet employed, they count as unemployed. The entrance of discouraged workers into the labor force during expansions causes the unemployment rate to decline less rapidly than we might otherwise expect.
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