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Potential GDP

Define potential GDP and explain its determinants. What are the factors that have been inhibiting India from realizing its potential GDP?

Mains GS paper 3

Like Gross Domestic Product, potential GDP also represents the market value of goods and services, when the economy is operating at a high rate of resource use. 

Potential GDP is an estimate of full employment which was an assumption of Classical economic thought and that aggregate demand does not exceed aggregate supply.

Determinants of Potential GDP:         

∙         Investment: The investment rate in the country influences GDP growth. When there is a drop-in investment and resulting slowdown of capital accumulation potential GDP also reduces.

∙         Inflation: Economic growth coupled with the Inflation rate. Higher the Inflation higher will be the GDP.

∙         Productivity: Higher production will lead to an increase in employment, which in turn increases the purchasing power of the people and higher the GDP. If the production decreases, the employment decreases and the country will experience recession.

Factors inhibiting potential GDP of India:

  • Global Financial Crises: Global financial crises like, the recession will impact on GDP of a country. A Recession is a situation where economic activities are slow down. If economic activities the slowdown will experience low employment and low productivity.  
  • Infrastructure: Lack of infrastructure facilities also leads to declining in the GDP of India. For economic growth, infrastructure plays an important role. If the country fails to develop these facilities, the development works will be hampered and the country will not be prosperous.
  •  Capital investment:  Investment boosts the Economy. It is a process of capital formation by a producer or increase in the existing stock of capital. It generates income, helps in wealth creation, to meets the country’s financial goals, and ultimately to achieves economic development. So, in order to increase GDP, we should encourage more investment in the country. 
  • Depreciation of currency: A Decrease in the value of our country’s currency with that of foreign currency is known as depreciation. Depreciating the value of the currency will impact low productivity, imports will become costlier, political instability, and lack of investment. 

Thus, potential GDP is not directly measurable, theoretically, it sounds good but in practice it has some limitations. It assumes full employment which is just a myth in the country like India. Economic activities are not stable, fluctuations are happening in these activities.  

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