Productive Capacity

Readers Question: Identify and explain clearly the determinants of a nation’s productive capacity. How does the concept of productive capacity differ from a nation’s actual GDP?

A nation’s productive capacity reflects potential output of an economy. It depends on:

1. Quantity of Labour. Size of workforce; in effect people of working age, economically active
2. Productivity of labour. This is the output per worker and depends on factors such as education, skills, motivation and ability to use technology.
3. Capital Stock. This is the amount of capital that can be used in the productive process. It includes machines, factories e.t.c.
4. Raw Materials. This is the amount of natural resources such as oil, coal, gas e.t.c
5. State of Technology. Technological innovations determine the productivity of labour and capital.

Difference between Productive Capacity and Actual GDP.

If an economy is at full employment it will be producing on its production possibility frontier. There will be no spare capacity and the actual GDP will equal the productive capacity.

However, if the economy is not operating on its production possibility frontier. If the economy has a degree of spare capacity then actual GDP will be less than potential GDP.

In a recession, there will be a negative output gap as the actual GDP, is less than potential. This can also be illustrated using a simple AD / AS diagram.

At Y1 actual output is less than potential.