Potential output - Definition and Overview

In economics, potential output refers to the highest level of real Gross Domestic Product that can be sustained. If actual GDP rises and stays above potential output, then (in the absence of wage and price controls) inflation tends to increase. This is because of the limited supply of workers and their time, capital equipment, and natural resources, along with the limits of our technology and our management skills. Potential output in macroeconomics corresponds to one point on the production possibilities frontier (or curve) for a society as a whole seen in introductory economics, reflecting natural, technological, and institutional contraints.

Potential output has also been called the "natural gross domestic product." If the economy is at potential, the unemployment rate equals the NAIRU or the "natural rate of unemployment."

Example Usage of Potential