HPAS/Allied Mains 2022 Answer Writing Challenge Day 174 : Model Answer

QUESTION: Define potential GDP and explain its determinants. (4 marks/ 60 words)

Answer:  

Potential GDP refers to the maximum output an economy can produce using its existing economic resources. It represents an economy’s long-run aggregate supply. At this level of output, the economy will fully utilize all its resources and work full employment.

Potential GDP rises along with the increased quantity quality and improved quality of production factors and technology. Its increase does not result in inflationary pressures in the economy. Therefore, in a graph, it will form a vertical line.

Another term for potential GDP is potential output, total output at full capacity, long-run output, or output at full employment.

Determinants of potential GDP

• Inflation
  The inflation rate in the country in a year influences the GDP growth. Higher inflation can boost the potential GDP rate.
• Recession
  Recession is the slowdown in growth rate for two consecutive quarters. Recession can significantly reduce the GDP.
• Factory output
  The output of finished goods from factories increases its contribution to GDP. Continuous growth will be suitable for high GDP.