In
economics
Economics () is a behavioral science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services.
Economics focuses on the behaviour and interac ...
, 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 total market value of all the final goods and services produced and rendered in a specific time period by a country or countries. GDP is often used to measure the economic performanc ...
(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 market (economics), 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 ...
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 go ...
),
inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
tends to increase as
demand
In economics, demand is the quantity of a goods, good that consumers are willing and able to purchase at various prices during a given time. In economics "demand" for a commodity is not the same thing as "desire" for it. It refers to both the desi ...
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 utilised amounts of the various inputs determine the quantity of output according to the rela ...
exceeds
supply
Supply or supplies 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 ...
. This is because of the
finite supply of workers and their time, of
capital equipment
Fixed assets (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. They are contrasted with current assets, such as cash, bank ac ...
, 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 Conceptual model, conceptual knowledge to achieve practical goals, especially in a reproducible way. The word ''technology'' can also mean the products resulting from such efforts, including both tangible too ...
and our
management
Management (or managing) is the administration of organizations, whether businesses, nonprofit organizations, or a Government agency, government bodies through business administration, Nonprofit studies, nonprofit management, or the political s ...
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 (AC) 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 is an important factor in determining how businesses will choose to price their pro ...
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 is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as output (econ ...
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 the proportion of people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work du ...
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.
Potential output has also been studied in relation
Okun's law
In economics, Okun's law is an Empirical research, 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" s ...
as to percentage changes in output associated with changes in the output gap and over time and in
decomposition
Decomposition 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 ess ...
of trend and
business cycle
Business cycles are intervals of general expansion followed by recession in economic performance. The changes in economic activity that characterize business cycles have important implications for the welfare of the general population, governmen ...
in the economy relative to the output gap.
[Nelson, Charles R. (2008]
"Trend/Cycle Decomposition"
''The New Palgrave Dictionary of Economics'', Palgrave-Macmillan
See also
*
GDP per capita
This is a list of countries by nominal GDP per capita. GDP per capita is the total value of a country's finished goods and services (gross domestic product) divided by its total population (per capita).
Gross domestic product (GDP) per capita is ...
Notes
{{Reflist
Macroeconomic aggregates
Management cybernetics
Price controls