Potential output

Potential output is the amount of production that an economy could produce if all the factors of production were optimally utilized. This unobservable variable represents the desired or target level that actual production should be. Potential production is sometimes defined as production adjusted for cyclic fluctuations.

Potential production is an extremely important factor shaping the decisions of the authorities responsible for economic policy. This erroneous measurement causes erroneous perception of cyclical conditions (cost and supply shocks), which in turn has an impact on monetary policy, inflation and supply gap.

Potential output increases in proportion to the increase in the stock of resources (eg population growth is an increase in the workforce, training expenditure is invested in human capital, the purchase of new machinery is augmentation of the capital stock, and technical progress enables more efficient use of existing resources.

However, it is important to remember that potential output is not the same as the maximum. People forced to work on two shifts would certainly be able to produce much more. Potential output determines the amount of output that can be achieved at equilibrium in all markets in the economy (market for goods and services, money and labor). This means, for example, that with a wage-balancing labor market, anyone who would like to work would find it. However, not everyone must necessarily want to work at a given rate, and there are always people who are changing jobs at the moment. It turns out that potential output does not mean zero unemployment rate. On the contrary, it is estimated that in Western European countries, potential output represents 5-10 percent of unemployment.

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