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Running Head: POTENTIAL OUTPUT
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Define Potential Output
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POTENTIAL OUTPUT
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Definition of Potential Output
In economics potential output is defined as the natural GDP of a country which denotes
the highest level of natural GDP that a county can sustain over a long time. It is the quantity of
production in a country when all the factors of production and resources such as technology,
labor, equipment, and natural resources are fully utilized. It may also portray the potential GDP
of a country when all its available resources are fully utilized. In essence, potential output is the
point at which a country has all factors of production in place to produce certain units of
production. It is the level at which the capital, labor, land, and human resources are available in
sufficient quantity to enable a country to produce economic output. The quantity that is produced
when these factors of production are available and efficiently used is what is referred to as
potential output. An economy that is in a position to produce at its potential, the output is said to
be operating on full employment capacity. It is the economic activity level at which the
aggregate demand and supply are consistent with a stable rate of inflation (Billi & Kahn 2011).
Determinants of the Potential Output Growth Rate
Natural GDP which is the Key driver of the potential output of a country is subjected to
natural, physical and institutional limits. These constraints have imposed certain restrictions on
the rate of potential output growth to the extent that a country's natural GDP cannot grow beyond
a certain limit. Only in a free market will the potential output remain below the actual GDP
because of the lack of price controls and wages (Parry, 1996). This clearly points out that the rate
of growth of potential output is determined by government policies that determine the rate of
wage paid to the employees and the price controls measures implemented in the economy.
Potential output is also determined by the factors affecting the production possibility
curve of the country’s economy and productivity. Consequently, the balance between a
POTENTIAL OUTPUT
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country’s institutional, technological, and natural constraints will determine the rate of growth of
potential ou...