In
economics
Economics () is the social science that studies the production, distribution, and consumption of goods and services.
Economics focuses on the behaviour and interactions of economic agents and how economies work. Microeconomics analyzes ...
, potential output (also referred to as "natural gross domestic product") refers to the highest level of
real
Real may refer to:
Currencies
* Brazilian real (R$)
* Central American Republic real
* Mexican real
* Portuguese real
* Spanish real
* Spanish colonial real
Music Albums
* ''Real'' (L'Arc-en-Ciel album) (2000)
* ''Real'' (Bright album) (2010) ...
gross domestic product
Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is oft ...
(potential output) that can be sustained over the long term. Actual output happens in real life while potential output shows the level that could be achieved.
Limits to output
Natural (physical, etc) and institutional constraints impose limits to growth.
If actual GDP rises and stays above potential output, then, in a
free market
In economics, a free market is an economic system in which the prices of goods and services are determined by supply and demand expressed by sellers and buyers. Such markets, as modeled, operate without the intervention of government or any ot ...
economy (i.e. in the absence of wage and
price controls),
inflation
In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
tends to increase as
demand
In economics, demand is the quantity of a good that consumers are willing and able to purchase at various prices during a given time. The relationship between price and quantity demand is also called the demand curve. Demand for a specific item ...
for
factors of production
In economics, factors of production, resources, or inputs are what is used in the production process to produce output—that is, goods and services. The utilized amounts of the various inputs determine the quantity of output according to the rel ...
exceeds
supply
Supply may refer to:
*The amount of a resource that is available
**Supply (economics), the amount of a product which is available to customers
**Materiel, the goods and equipment for a military unit to fulfill its mission
*Supply, as in confidenc ...
. This is because of the
finite
Finite is the opposite of infinite. It may refer to:
* Finite number (disambiguation)
* Finite set, a set whose cardinality (number of elements) is some natural number
* Finite verb, a verb form that has a subject, usually being inflected or marke ...
supply of workers and their time, of
capital equipment
A fixed asset, also known as long-lived assets or property, plant and equipment (PP&E), is a term used in accounting for assets and property that may not easily be converted into cash. Fixed assets are different from current assets, such as cash ...
, and of
natural resources
Natural resources are resources that are drawn from nature and used with few modifications. This includes the sources of valued characteristics such as commercial and industrial use, aesthetic value, scientific interest and cultural value. ...
, along with the limits of our
technology
Technology is the application of knowledge to reach practical goals in a specifiable and Reproducibility, reproducible way. The word ''technology'' may also mean the product of such an endeavor. The use of technology is widely prevalent in me ...
and our
management
Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a Government agency, government body. It is the art and science of managing resources of the business.
Management includ ...
skills. Graphically, the expansion of output beyond the natural limit can be seen as a shift of production volume above the optimum quantity on the
average cost In economics, average cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced (the output Q):
AC=\frac.
Average cost has strong implication to how firms will choose to price their commodities. Firms’ sale ...
curve. Likewise, if GDP persists below natural GDP, inflation might decelerate as suppliers lower prices in order to sell more products, utilizing their excess production-capacity.
Potential output in
macroeconomics corresponds to one
point
Point or points may refer to:
Places
* Point, Lewis, a peninsula in the Outer Hebrides, Scotland
* Point, Texas, a city in Rains County, Texas, United States
* Point, the NE tip and a ferry terminal of Lismore, Inner Hebrides, Scotland
* Point ...
on the
production–possibility curve for a society as a whole, reflecting its natural, technological, and institutional constraints.
Resources utilization
Potential output has also been called the "natural gross domestic product." If the economy is said to be at a potential GDP level, the
unemployment
Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work during the refere ...
rate ostensibly equals the
NAIRU
Non-accelerating inflation rate of unemployment (NAIRU) is a theoretical level of unemployment below which inflation would be expected to rise. (the "natural rate of unemployment"). There is great disagreement among economists as to what these rates actually are, while the concept itself of NAIRU is rejected by
Post-Keynesians
Post-Keynesian economics is a school of economic thought with its origins in ''The General Theory'' of John Maynard Keynes, with subsequent development influenced to a large degree by Michał Kalecki, Joan Robinson, Nicholas Kaldor, Sidney We ...
as non-valid.
The difference between potential output and actual output is referred to as
output gap or GDP gap; it may closely track lags in industrial
capacity utilization.
Potential output has also been studied in relation
Okun's law
In economics, Okun's law is an empirically observed relationship between unemployment and losses in a country's production. It is named after Arthur Melvin Okun, who first proposed the relationship in 1962. The "gap version" states that for ever ...
as to percentage changes in output associated with changes in the output gap and over time. and in
decomposition
Decomposition or rot is the process by which dead organic substances are broken down into simpler organic or inorganic matter such as carbon dioxide, water, simple sugars and mineral salts. The process is a part of the nutrient cycle and is e ...
of trend and
business cycle
Business cycles are intervals of expansion followed by recession in economic activity. These changes have implications for the welfare of the broad population as well as for private institutions. Typically business cycles are measured by examin ...
in the economy relative to the output gap.
[Nelson, Charles R. (2008]
"Trend/Cycle Decomposition"
''The New Palgrave Dictionary of Economics'', Palgrave-Macmillan
Notes
{{Reflist
Macroeconomic aggregates
Price controls