Answer to Question #207938 in Macroeconomics for adi

Question

What is meant by potential GDP? How is it different from actual GDP?

Answer 1

Potential GDP is a theoretical construct that estimates the value of the output that the economy would have created if labor and capital were utilized at their maximum sustainable rates—that is, rates that are consistent with stable growth and inflation.

The output gap is the difference between the level of real GDP and potential GDP. When the output gap is positive—when GDP exceeds potential—the economy is functioning at a higher capacity than it can sustain, and inflation is imminent. The output gap is negative when GDP falls short of its potential.