Potential GDP and how it differs from actual domestic product

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:46

Potential GDP is the domestic product of the state, which can be provided to the maximum extent with the full use of available resources.

This state is called full employment. There is another concept - real GDP, for the formation of which producers create and sell the required amount of products for a certain time at various price levels. When analyzing macroeconomic indicators, it is customary to single out long-term and short-term periods. Thus, the behavior of economic entities in the long run can be described by the classical model. A free market without government intervention automatically ensures the use of resources in production, which leads to the achievement of potential GDP.

Potential GDP is determined by the amount of technology and resources available, howevermay be independent of the price level. That is why the long-run aggregate supply curve is vertical.

Potential GDP obeys the law of money neutrality. Thus, the vertical direction of the curve indicates the degree of supply of output at the level of such GDP by market forces and competition in the long run. At the same time, the price level can have different values and depend on the amount of money in the economy. And the other side of this economic law is that in the presence of high money emission, high prices can be traced, and in long-term planning, the money supply affects both prices and output.

When the amount of resources in the economy increases, the development of technical progress can be traced and, accordingly, potential GDP increases, and its curve on the graph should shift to the right. But with a reduction in resources or a technical regression, everything should happen the other way around.

A significant number of economists believe that GDP (actual and potential) can reflect the long-term in macroeconomics. At the same time, deviations of the first type of domestic product from the second are quite successfully eliminated by the market.

However, modern economists have concluded that there is a short period (an example would be a quarter) in which the classic approach to money neutrality cannot work. In other words, any change in the money supply willsignificant impact on both the price level and potential GDP. Thanks to this statement, a new concept appeared - short-term GDP, to reflect the dynamics of which the aggregate supply curve is no longer vertical, but rather horizontal.

This curve reflects the possibility of increasing the ability of business entities to produce products at a certain price level. This fact is confirmed by the presence of noticeable lags between the actual GDP and its potential level. In other words, the domestic economy is not working at full capacity.