Production potential

In economics, the term production potential denotes the production that could be achieved if all economic production factors were fully utilized . This indicator for the growth of an economy can only be estimated approximately, but cannot be determined exactly. If the degree of utilization is 100%, the production potential has been fully used.

definition

The production potential corresponds to the production capacity (total economic output) of an economy with normal employment of all economic production factors. The Advisory Council considers normal capacity utilization to be given when the existing production factors are used to 96.75%. In the literature, the terms “natural level of production” or “normal level of production” are often used as synonyms. Another concept defines the production potential as the maximum efficiency of an economy with full employment and a given stock of production factors. Here, maximum performance is not to be understood as the technically possible maximum production, but that production that can be generated without the build-up of additional inflationary pressure.

The following equation defines the normal production level  : ${\displaystyle {Y_{n}}}$

${\displaystyle F\left(\ 1-{\frac {Y_{n}}{L}}{,}{z}\right)={\frac {1}{1+\mu }}}$

variables

• ${\displaystyle {L}}$ : Number of the labor force
• ${\displaystyle {z}}$ : Collective variables (includes institutional factors that influence wage setting, such as: non-wage costs, unemployment benefits, trade union power, protection against dismissal, etc.)
• ${\displaystyle \mu }$ : Company profit margin

Mathematical derivation

The normal level of production is shaped by the structural conditions; especially from those of the labor market. First, some assumptions need to be made:

1. Capital and technical know-how are given below.
2. The aggregate production function has on the assumption that the company only with the production factor produce work, the form: , where the production referred to employment and the labor productivity . Furthermore, a constant marginal product of labor is assumed, i.e. H. if employment rises (falls) by a certain amount, production rises (falls) by the same amount. Furthermore, the labor productivity is set as constant. The production function arises:, d. H. one employee produces exactly one production unit. ${\displaystyle {Y}={A}\cdot {N}}$ ${\displaystyle {Y}}$ ${\displaystyle {N}}$ ${\displaystyle {A}}$ ${\displaystyle {A}}$ ${\displaystyle {Y}={N}}$
3. There is no perfect competition in the goods market; H. companies offer their products at a price above marginal costs . The prices are set based on the function , representing the wage rate and the profit markup. ${\displaystyle {P}={(1+\mu )}\cdot {W}}$ ${\displaystyle {W}}$ ${\displaystyle \mu }$
4. The actual price level equal to the expected price level: . ${\displaystyle {P}={P^{e}}}$

Wages are described in the labor market by the following function:

${\displaystyle {W}={P^{e}}{F(u,z)}}$( Wage setting function )

Assuming and transforming, one obtains the function: ${\displaystyle {P}={P^{e}}}$

${\displaystyle {\frac {W}{P}}={F(u,z)}}$   (1)

There is a negative relationship between real wages and the unemployment rate; H. the higher (lower) the unemployment rate, the lower (higher) the real wage.

The price setting is described by the following already converted function: (see also the price setting function )

${\displaystyle {\frac {W}{P}}={\frac {1}{1+\mu }}}$   (2)

If the companies increase their profit markup, the prices also increase and thus the real wage falls (with the wage rate remaining the same).

An equilibrium in the labor market occurs when the real wage determined by the wage-setting function corresponds to the real wage induced by the price-setting function. Substituting equation (1) into equation (2) one obtains the function of the natural unemployment rate : ${\displaystyle {u_{n}}}$

${\displaystyle {F(u_{n},z)}={\frac {1}{1+\mu }}}$   (3)

The unemployment rate indicates the ratio of the unemployed (U) to the number of the working population (L). The number of unemployed (U) is the difference between the working population (L) and the number of employees (N). By rearranging the equation we obtain the expression for the natural level of employment: . ${\displaystyle {u}}$ ${\displaystyle {u}={\frac {U}{L}}={\frac {L-N}{L}}=1-{\frac {N}{L}}}$ ${\displaystyle {N_{n}}={L}\cdot {(1-u_{n})}}$

Assuming that the production function of an economy is also given, a natural level of production results from the equation . By rearranging the equation and inserting it into equation (3), the function that defines the natural level of production is created: ${\displaystyle {Y}={N}}$ ${\displaystyle {Y_{n}}}$ ${\displaystyle {Y_{n}}={N_{n}}={L}{(1-u_{n})}}$ ${\displaystyle {u_{n}}}$ ${\displaystyle {Y_{n}}}$

${\displaystyle F\left(\ 1-{\frac {Y_{n}}{L}}{,}{z}\right)={\frac {1}{1+\mu }}}$

Natural production potential in the AS-AD model

In the short term , it is possible that production will deviate from its natural level. The reason for this is that the short-term aggregated supply curve ( AS curve ) is positively inclined. (The Keynesian theory of rigid wage rates and the New Keynesian theory of rigid prices offer an explanation for the fact that prices do not move uniformly along the short-term AS curve .) This means that if the price level increases (decreases) in the short term, this Supply of goods and services increased (decreased). If the expected price level (including wages) rises, companies adjust their prices, i. H. these offer fewer goods at a given price level. Ultimately, production depends not only on the expected price level, but on all factors that influence the position of the aggregated demand curve ( AD curve ). These are the money supply (M), government spending (G) and taxes (T).

An adjustment process will take place in the medium term . Overall economic production is returning to its natural level. The prices adapt to the expected price level. If production is above its natural equilibrium, the price level also rises. This causes demand and ultimately production to decline until it reaches its natural level.

In the long run , changes in aggregate demand only have an impact on the price level. Production and employment will remain at their natural level in the long term.

Influencing factors

The development of the production potential depends primarily on the supply factors, such as B. the investments made in the country . In addition, the production potential is also influenced by the development of technical progress (i.e. productivity ), since an increase in this allows a more efficient use of the available capital stock . Another influencing factor is the amount of work used in the production process . At the same time, however, demand factors also have an indirect effect, e.g. B. on the investment demand, on the production potential. This raises a serious problem of endogeneity when correctly determining the production potential.

meaning

1. In the sense of Okun (1962), production potential was initially simply understood to mean the economic output of an economy at full employment . In this way it should be possible to measure what one percentage point of unemployment “costs” in economic terms. Nowadays, an unemployment rate is usually defined as "full employment" that is inflation-neutral, ie leaves the rate of price increase unchanged. In this sense the concept is of great importance e.g. B. for determining the structural deficit of the state budget.
2. The development of the production potential over time serves as an indicator for the economic growth of an economy.
3. With the help of actual production, the production potential can provide information about the economic state (degree of capacity utilization) in an economy. The deviation of actual production from the natural level of production is also known as the output gap .
4. The production potential is also used in the potential-oriented monetary policy of the Deutsche Bundesbank. Within the framework of its monetary policy, which is geared towards price level stability, the development of the money supply is based on the development of potential production.
5. In the regulations on the debt brake and the European Fiscal Compact , the government's financial balance is divided into a cyclical and a structural financial balance. The structural or cyclically adjusted financial balance should not fall below certain values ​​in relation to the gross domestic product . The structural budget balance (if negative, the structural deficit) is defined as the budget balance that would result if gross domestic product were equal to potential output, i.e. if the output gap were zero.

Measurement of potential production

While the microeconomic production potential can usually be determined relatively reliably via surveys, as it is usually technically specified, the calculation of an economic production potential is extremely difficult, as it is not possible to clearly determine when full utilization of all production factors will be achieved.

The economic production potential can be estimated with the help of a production function (e.g. a Cobb-Douglas production function ). To do this, however, it is necessary to know the factor input amounts; As mentioned above, these depend on the investments made, the efficiency of business processes and technological progress.

In addition, the development of the production potential can also be estimated by comparing the current gross domestic product with the trend. However, this is difficult because changes in the trend cannot be recognized without underlying economic factors. In practice, different concepts are pursued to determine the production potential. On the one hand, multivariate theory-based approaches are used to estimate production functions using econometric methods . On the other hand, univariate , purely statistical methods are used to analyze time series. Common estimation methods are:

1. Extrapolation from company survey on capacity utilization,
2. Peak-to-peak method ,
3. Hodrick-Prescott filter (HP filter) ( European Commission ),
4. Estimates of the production function ( Deutsche Bundesbank ),
5. capital stock-oriented method ( Expert Council ).

Development of potential production over time

In the long term, the growth rate of potential output in industrialized countries tends to decrease. This is due to the low and in some cases even negative population growth , low domestic investment rates and falling productivity growth. In the United States, for example, potential growth was around four percent per year in the mid-1960s, while it had fallen to below three percent per year until 1990.

The IT -revolution made from the mid-1990s in the US for some increase in potential growth by nearly half a percentage point and was the basis of the observed boom in those years. After the US economy had largely realized the productivity advantages through the use of information and communication technology , potential growth fell back to well below three percent in the early 2000s. Various studies believe that the rate will likely drop to below 2.5 percent in the next few years. This scenario would presumably have serious effects on state economic policy and corporate investment decisions.

For Germany, a relatively constant growth in production potential of just over two percent can be observed from the 1970s. In contrast to the USA, however, potential growth in Germany fell to less than two percent from the mid-1990s. In 2004, the German Council of Economic Experts calculated a growth rate in potential production of around 1.5 percent. The lower value for Germany results, among other things, from the lower population growth.

supporting documents

1. ↑ Ritterbruch, Klaus; Macroeconomics, 11th edition, Munich 2000, page 136
2. ^ "Vahlens Großes Wirtschaftslexikon"; Editors: E. Dichtl, O.Issing, Volume 2 LZ, Munich 1987, page 386
3. ↑ Arthur M. Okun; see. AM Okun (1962), Potential GNP: Its measurement and its significance; Proceedings of the Business and Economic Statistics Section, American Statistic Association, pp. 98-104.
4. ↑ Blanchard, Olivier / Illing, Gerhard “Macroeconomics”, Pearson Studium, 3rd, updated edition, Munich 2003, pages 189–197
5. ↑ Blanchard, Olivier / Illing, Gerhard “Macroeconomics”, Pearson Studium, 3rd, updated edition, Munich 2003, page 214
6. ↑ Blanchard, Olivier / Illing, Gerhard “Macroeconomics”, Pearson Studium, 3rd, updated edition, Munich 2003, page 216
7. ↑ Gustav Horn and Silke Tober (2007): How strong can the German economy grow? On the errors and confusions of the potential calculation , IMK Report No. 17, January 2007. (PDF; 106 KiB)
8. ↑ Arthur M. Okun (1962): Potential GNP: Its Measurement and Significance ( Memento of September 7, 2006 in the Internet Archive ) , Cowles Foundation Paper 190, Reprinted from the 1962 Proceedings of the Business and Economics Statistics Section of the American Statistical Association . (PDF, 562 KiB)
9. ↑ Ritterbruch, Klaus; Macroeconomics, 11th edition, Munich 2000, page 137
10. ↑ ^{a b} Cf. Achim Truger, Henner Will, Institute for Macroeconomics and Business Cycle Research Working Paper (January 2012): "Prone to design and pro-cyclical: The German debt brake in a detailed analysis"
11. ↑ Gustav Horn and Silke Tober (2007): How strong can the German economy grow? On the errors and confusions of the potential calculation, IMK Report No. 17, January 2007.
12. ^ The Economist (2006), Slow road ahead, October 28, 2006, pp. 85-86.
13. ↑ Expert Council for the Assessment of the Overall Economic Situation (2004). "The production potential in Germany: Estimation methods and results", excerpt from the annual report 2003/04 ( memento of the original from January 1, 2007 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice. 

Literature sources

• Arthur M. Okun; see. AM Okun: Potential GNP: Its measurement and its significance; Proceedings of the Business and Economic Statistics Section , American Statistic Association; 1962
• Blanchard, Olivier / Illing, Gerhard: Macroeconomics , Pearson Studies, 3rd, updated edition, Munich 2003;
• Gustav Horn and Silke Tober: How fast can the German economy grow? On the errors and confusions of the potential calculation , IMK Report No. 17, January 2007
• Ritterbruch, Klaus; Macroeconomics , 11th edition, Munich 2000;
• "Vahlens Großes Wirtschaftslexikon"; Editors: E.Dichtl, O.Issing, Volume 2 L – Z, Munich 1987;

Web links

• The production potential in Euroland (PDF file; 61 kB)
• BMF monthly report - October 2006 (PDF file)
• SVR excerpt from the 2003/04 annual report (PDF file; 496 kB)