Explain Potential Output As A Determinant Of Aggregate Supply?


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Tariq Habib answered
The underlying foundation of aggregate supply is the productive capability of the economy, or its potential output. The potential output represents the maximum output that the economy can produce without triggering rising inflationary pressure. That is, country's potential output is the maximum sustainable production given the technology, managerial skills, capital, labor, and resources that are available.

Over the long run, aggregate supply depends primarily upon potential output. Hence, long run aggregate supply is determined by the same factors, which influence long run growth: the amount and quality of available labor, the quantity of machines and other capital goods used by workers, the level of technology, and so on. The analysis of long run growth trends therefore concerns both the growth of potential output and the determination of aggregate supply.

Potential output is obviously a moving target. As the economy grows, potential output increases as well, and the aggregate supply shifts to the right. The key determinants of aggregate supply, broken down into factors affecting potential output and production costs. From our analysis of economic growth, we know that the prime factors determining the growth in potential output are the growth in inputs and technological progress.

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