Potential GDP

1. Potential GDP is one of the theoretical aspects of national income accounting which assumes that an economy has achieved full employment and that aggregate demand does not exceed aggregate supply.
2. Output Gap :
   1. The output gap can also move in positive and negative directions, similar to GDP’s rise and fall. When the actual output is more than full-capacity output, it’s considered positive output. It can be observed during the high demand for the goods and to meet the demand, factories, and workers operate far above their most efficient capacity.
   2. Due to any reason, when the actual output reduces as compared to the real production of an economy at full capacity, the condition is negative output. As the demand weakens, there is a spare capacity or slack in the economy.­
   3. Whenever there is an output gap either positive or negative, it is considered an unfavourable indication of the efficiency of an economy. Positive output is considered beneficial in terms of the economy’s growth, but it also means that to meet the demand, businesses and workers have to work beyond their maximum efficiency. A positive output gap increases both the labour as well as the good’s prices due to an increase in demand. Hence, it spurs inflation in the economy.
   4. Alternatively, a lack of demand for goods and services in the economy leads to negative output, which results in the companies and employees operating below their maximum efficiency levels.
   5. A negative output gap indicates a sluggish economy and shows the future possibility of a declining GDP growth rate and potential recession due to overall low economic demand, the wages, and the prices of goods typically falling. like other national income accounting methods, potential GDP also computes the market value of all goods and services but rather than capturing the current state of a nation’s economic activity, it focuses on the estimation of the highest level of output that can be supported by an economy over a while.
      

      Determinants of Potential GDP

      ●    Capital Stock: In an economy,  capital stock is the plant, equipment, and other assets that help with production, the extent of economic output and Potential GDP is decided by the capital stock’s availability. ●    Labour Force: At any given moment in time, the quantities of capital, land, etc,  are typically fixed, but the quantity of labour employed varies, therefore, in the short-run, Potential GDP depends on the quantity of labour employed, which depends on demographic factors and participation rates ●    Non-accelerating Inflation Rate of Unemployment: It is the specific unemployment rate at which the rate of inflation stabilises – inflation will neither increase nor decrease, it is also one of the determinants of Potential GDP ●      Other determinants of Potential GDP are the level of labour efficiency, labour market efficiency, production capacity, sufficient liquidity, government fiscal support, etc

      Factors Inhibiting India From Realising Its Potential GDP:

      1. Negative Output Gap: When an actual output decreases than what an economy could produce at full capacity, it is a negative output gap. In the economy when there is a spare capacity or slack present due to weak demand, it is known as a negative output gap.
      2. Fall In Private Consumption: Private consumption is the prime component of India’s GDP as it contributes a significant share of GDP (More than 55%). The Indian economy experienced a sharp decline in private consumption expenditure in the past few quarters.  Such a decline in private consumption de-incentivises firms in producing more goods, thereby the economy is left with unutilised resources and labour force.
      3. Mounting NPAs of Banks: The Indian banking system is under the huge burden of NPAs (Non-Performing Assets), which has tremendously reduced banks’ lending capacity. This has severely affected businesses, production houses and, particularly the real estate segment. Such liquidity shortages reduce the productive capacity of the economy.
      4. Unemployment: Huge unemployment in India is also one of the major factors that inhibit India from realising its Potential GDP.
      5. Informal Economic Activities: Most of the economic activities in India are informal or unorganised and the size of such unorganised sectors is considerably huge but not accounted for in GDP. Therefore, the value of such an economy is not recorded in the national account book and remains unreleased.
      6. Other Factors: Weak intellectual property rights, low expenditure on R&D, contract enforcement issues, etc.

      Output Gap:

      1. The output gap is an economic measure when the difference between the actual output of an economy and its potential output is found. When an economy is at its highest efficiency, the maximum amount of goods and services an economy can turn out when it is most efficient is the potential output of that economy. It means the economy is at full capacity. Often, the potential output is also considered to be the production capacity of the economy.­
      2. The output gap can also move in positive and negative directions, similar to GDP’s rise and fall. When the actual output is more than full-capacity output, it’s considered positive output. It can be observed during the high demand for the goods and to meet the demand, factories, and workers operate far above their most efficient capacity.
      3. Due to any reason, when the actual output reduces as compared to the real production of an economy at full capacity, the condition is negative output. As the demand weakens, there is a spare capacity or slack in the economy.­
      4. Whenever there is an output gap either positive or negative, it is considered an unfavourable indication of the efficiency of an economy. Positive output is considered beneficial in terms of the economy’s growth, but it also means that to meet the demand, businesses and workers have to work beyond their maximum efficiency. A positive output gap increases both the labour as well as the good’s prices due to an increase in demand. Hence, it spurs inflation in the economy.
      5. Alternatively, a lack of demand for goods and services in the economy leads to negative output, which results in the companies and employees operating below their maximum efficiency levels.
      6. A negative output gap indicates a sluggish economy and shows the future possibility of a declining GDP growth rate and potential recession due to overall low economic demand, the wages, and the prices of goods typically falling.

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