Potential GDP refers to the maximum level of output an economy can produce sustainably when all resources—labour, capital, and technology—are fully and efficiently utilized without generating inflationary pressure.

UPSC Prelims Pointers:

• It represents the economy’s long-term productive capacity, not actual output.
• The gap between Actual GDP and Potential GDP is called the Output Gap.
• Positive output gap → inflationary pressure; Negative output gap → economic slack/unemployment