Answer to Question #285140 in Macroeconomics for Jayrick

Question

Two separate capacity constraints are discussed in this chapter: (1) the actual physical capacity of existing plants and equipment, shown as the vertical portion of the short-run AS curve, and (2) potential GDP, leading to a vertical long-run AS curve. Explain the difference between the two. Which is greater, full-capacity GDP or potential GDP? Why?

Answer 1

Solution:

Full-capacity GDP, also known as real GDP, refers to the GDP level which an economy would attain if it reported full employment, while potential GDP refers to the highest level of real GDP that can be sustained over the long term.

The difference between the level of full-capacity GDP and potential GDP is referred to as the output gap.

 

The full-capacity GDP must always be greater than the potential GDP to keep the rate of inflation down and to enhance economic growth.