Question

Define potential GDP and its use in economic models

Answer 1

Potential GDP in the market is the point of the output where all the resources in the market are fully employed and there is no inflation in the market. This is the long run equilibrium were the demand, short run supply and the long run supply are all equal. At this point the maximum output can be achieved without having an inflation.

It is used to determine the ideal condition of the market, if the current GDP is less than the potential GDP then the market is experiencing a deflationary gap and if the market is above the potential GDP then the market is experiencing an inflationary gap. It helps the policy market make a decision in the market