Empirical methods Prescriptive and policy In economics, potential output (also referred to as "natural gross domestic product") refers to the highest level of real gross domestic product (potential output) that can be sustained over the long term.
If actual GDP rises and stays above potential output, then, in a free market economy (i.e. in the absence of wage and price controls), inflation tends to increase as demand for factors of production exceeds supply.
This is because of the finite supply of workers and their time, of capital equipment, and of natural resources, along with the limits of our technology and our management skills.
Graphically, the expansion of output beyond the natural limit can be seen as a shift of production volume above the optimum quantity on the average cost curve.
Potential output in macroeconomics corresponds to one point on the production–possibility curve for a society as a whole, reflecting its natural, technological, and institutional constraints.