Ineconomics,potential output (also referred to as "natural gross domestic product") refers to the highest level ofrealgross domestic product (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.
Natural (physical, etc) and institutional constraints impose limits to growth.
If actual GDP rises and stays above potential output, then, in afree market economy (i.e. in the absence of wage andprice controls),inflation tends to increase asdemand forfactors of production exceedssupply. This is because of thefinite supply of workers and their time, ofcapital equipment, and ofnatural resources, along with the limits of ourtechnology and ourmanagement skills. Graphically, the expansion of output beyond the natural limit can be seen as a shift of production volume above the optimum quantity on theaverage 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 inmacroeconomics corresponds to onepoint on theproduction–possibility curve for a society as a whole, reflecting its natural, technological, and institutional constraints.
Potential output has also been called the "natural gross domestic product." If the economy is said to be at a potential GDP level, theunemployment rate ostensibly equals theNAIRU (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 byPost-Keynesians as non-valid.[1][2][3]
The difference between potential output and actual output is referred to asoutput gap or GDP gap; it may closely track lags in industrialcapacity utilization.[4]
Potential output has also been studied in relationOkun's law as to percentage changes in output associated with changes in the output gap and over time[5] and indecomposition of trend andbusiness cycle in the economy relative to the output gap.[6]
