Potential GDP

Potential GDP

• Gross Domestic Product is a measure of the value of all of the goods and services produced in the economy in a given period.
• Potential GDP is a theoretical construct, an estimate of the value of the output that the economy would have produced if labour and capital had been employed at their maximum sustainable rates—that is, rates that are consistent with steady growth and stable inflation.
• The difference between the level of real GDP and potential GDP is known as the output gap. When the output gap is positive—when GDP is higher than potential—the economy is operating above its sustainable capacity and is likely to generate inflation. When GDP falls short of potential, the output gap is negative.

Actual GDP and Potential GDP

• Actual GDP refers to the real output actually produced by the economy in a given period.
• Potential GDP refers to the level of output that an economy can produce when its resources are used efficiently and normally, without excessive inflationary pressure.
• During an upturn, actual GDP may rise above the potential GDP level.
• During a downturn, actual GDP may fall below the potential GDP level.
• Thus, business cycles show the movement of actual GDP around its long-term trend or potential GDP.