© 2012, Federal Reserve Bank of St. Louis. Inflation, whether positive or negative, is a factor that constantly affects a country or region. To some, it reflects a world in which every worker is matched with the perfect job, every good idea is implemented, and the bad ones are ignored. leads to a decrease in the natural rate of unemployment and an increase in potential GDP. Because more employment means more production and higher inflation. If we use 2007 estimates, the output gap for 2011:Q4 would be –11.3 percent. If we only looked at real GDP, we would be pretty confused. Of course, this whole concept is a part of Keynesian economics, which is just one theory of economics. I understand that real GDP is variant and potential is constant. Potential GDP is more of an estimation. It is based on a constant inflation rate, so potential GDP cannot rise any higher, but real GDP can go up. And can we say the same thing about the unemployment rate? I had several questions about real and potential GDP on my economy test last week. It would also mean that resources are being mined and converted into products without any sort of excess waste in the process.Of course, the potential GDP is just an ideal toward which countries may strive but usually never reach. Potential gross domestic product (GDP) is a theoretical concept that means different things to different people. According to CBO estimates of potential GDP, U.S. actual GDP fell about 10 percent short of potential during 2009:Q1. If I understood this correctly, that means that only real GDP is accurate. Is that why real GDP sometimes goes higher than potential GDP?

Real GDP shows us how many more jobs and how much more production is necessary to get there. We need to calculate potential GDP to know what our (economists, government agencies and industries) next step should be. Think of it as a goal. Instead, they estimate potential GDP by constructing measures of the trend in actual GDP that smooth out business cycle fluctuations. The estimates of trend output vary only by the number of years of data used in the process. We would calculate the potential GDP as follows:(recall percentages can be converted to decimal by dividing them by 100.  e.g 95% = Consider an economy where the natural rate of unemployment is 3% and the actual rate of unemployment is 5% and the GDP of the economy is 1.42 trillion dollars. This doesn't meant that there are no unemployed individuals. Real potential GDP is the CBO’s estimate of the output the economy would produce with a high rate of use of its capital and labor resources. But why does potential GDP matter? -does not affect potential GDP. Clear answers for common questions If the economy is said to be at a potential GDP level, the unemployment rate ostensibly equals the NAIRU (the "natural rate of unemployment"). I answered true and got it wrong. As a result, economic leaders try to find ways to minimize that gap so that production output can more closely resemble potential levels.If you try to push the real GDP above potential GDP, what will happen and why? In addition, general inefficiency, whether caused by government interference or simple business incompetence, can also drag down gross domestic products.Since there is rarely ever an occasion when a country can reach its potential GDP, economists often study the lag between what a country can produce and what it actually does produce. One of the major economic factors which helps to measure economic strength is the gross domestic product. GDP per capita for example, is another excellent tool that allows us to compare our growth with other countries'. Basically, it's all based on employment. There is another formula that might be required which is the percentage GDP gap which is:When the output gap is negative the economy is said to be operating .

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