What is potential output?

• A. The level of real GDP the economy can produce at full employment given available resources and technology.
• B. The maximum price level the economy can sustain in the long run.
• C. The level of nominal GDP in a given year.
• D. The actual observed GDP in the economy.

Answer: (A)

Potential output is the level of real GDP the economy can sustain over the long run when its resources—labor, capital, and technology—are fully and efficiently utilized. It represents the economy’s productive capacity given existing technology and institutions, essentially what the economy could produce if unemployment were at its natural rate and there were no cyclical slack. This concept is tied to the long-run aggregate supply, which is vertical because, in the long run, price changes don’t change the economy’s capacity to produce. Actual GDP can bounce above or below this level due to short-run demand shifts, but potential output stays tied to sustainable capacity. The other options describe the price level, nominal GDP, or the actual observed GDP, none of which capture the sustained, full-employment production level represented by potential output.