Foundations of Economics, 8th Edition

24.1 Potential GDP

MyEconLab Concept Video

Potential GDP is the value of real GDP when all the economy’s factors of production—labor, capital, land, and entrepreneurial ability—are fully employed. It is vital to understand the forces that determine potential GDP for three reasons. First, when the economy is at full employment, real GDP equals potential GDP; so actual real GDP is determined by the same factors that determine potential GDP. Second, real GDP can exceed potential GDP only temporarily as it approaches and then recedes from a business cycle peak. So potential GDP is the sustainable ­upper limit of production. Third, real GDP fluctuates around potential GDP, which means that on the average over the business cycle, real GDP equals ...