What does Potential GDP represent?

Potential GDP represents the maximum level of output that an economy can produce when operating at full employment, which reflects the economy's most efficient use of resources. This concept is fundamental in macroeconomics as it highlights the sustainable capacity of an economy without leading to inflationary pressures. When the economy is at its potential GDP, it means that all available resources, including labor and capital, are utilized effectively, and unemployment is at its natural rate.

This measurement is crucial for policymakers and economists because it allows them to assess the economy’s performance relative to its capacity. If actual GDP is below potential GDP, it suggests that there are unused resources and possibly higher unemployment. Conversely, if actual GDP exceeds potential GDP, it may signal overheating in the economy, which can lead to inflation as demand outstrips supply.

The other choices do not accurately represent the definition of Potential GDP. Actual output refers to the real GDP produced in a given period, expected growth is a forecast about future performance, and GDP adjusted for inflation pertains to real GDP, which accounts for price changes over time. Thus, the rightful focus on full employment and the capacity for maximum production underlines why Potential GDP is defined as such.