POTENTIAL GDP:
- The highest market value of goods and services that can be produced in an economy by utilizing the whole potential of the economy over a period of time is referred to as potential GDP.
- Like GDP, potential GDP represents the market value of goods and services, but rather than capturing the current status of a nation’s economic activity, potential GDP attempts to estimate the highest level of output an economy can sustain over a period of time.
- It assumes that an economy has achieved full employment and that aggregate demand does not exceed aggregate supply.
- When GDP falls short of that natural limit, it means the country is failing to live up to its economic potential.
OUTPUT GAP :
The difference between potential and real GDP is called the output gap. If real GDP falls short of potential GDP (i.e., if the output gap is negative), it means demand for goods and services is weak. It’s a sign that the economy is not realizing its full potential.
If the real GDP exceeds potential GDP (i.e., if the output gap is positive), it means the economy is producing above its sustainable limits, and that aggregate demand is outstripping aggregate supply. In this case, inflation and price increases are likely to follow.
Potential GDP is determined by Inflation,Recession,Factoryoutput,Lowproductivity,Currencydepreciation,Decrease in foreign capital and Lack of Infrastructure.
INFLATIONARY GAP: An inflationary gap refers to the positive difference between the real GDP and potential GDP at full employment. An inflationary gap endures when the demand for goods and services exceeds production due to higher overall employment levels, increased trade, or high government expenditure. In such case ,the real GDP can surpass the potential GDP, resulting in an inflationary gap. The inflationary gap is named because the comparable rise in real GDP causes an economy to develop its consumption, leading prices to climb in the long run. The inflationary gap depicts the point in business cycle when the economy is developing.
When the potential GDP is higher than the
real GDP, the gap is referred to as a deflationary
gap. The other kind of output gap is the
recessionary gap, which represents an economy operating below its
full-employment equilibrium.
