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 anal ...

, potential output (also referred to as "natural gross domestic product") refers to the highest level of real

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 of ...

(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 Price controls are restrictions set in place and enforced by governments, on the prices that can be charged for goods and services in a market. The intent behind implementing such controls can stem from the desire to maintain affordability of good ...

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 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. This is because of the finite supply of workers and their time, of capital equipment, 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 reproducible way. The word ''technology'' may also mean the product of such an endeavor. The use of technology is widely prevalent in medicine, scien ...

and our

management Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managing resources of the business. Management includes the activitie ...

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 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 Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and ...

corresponds to one 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 refe ...

rate ostensibly equals the NAIRU (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 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 Capacity utilization or capacity utilisation is the extent to which a firm or nation employs its installed productive capacity. It is the relationship between output that ''is'' produced with the installed equipment, and the potential output whic ...

. 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 ...

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