Association of Chartered Certified Accountants (ACCA) Certification Practice Test

Which of the following is true about potential output?

1. It is solely determined by consumer demand

2. It is based on resource availability and productivity levels

3. It fluctuates dramatically with trade cycles

4. It remains constant regardless of economic conditions

The correct answer is: It is based on resource availability and productivity levels

Potential output refers to the maximum level of output an economy can produce when operating at full capacity, given the availability of resources and the prevailing productivity levels. This concept emphasizes the importance of the factors of production, such as labor, capital, and technology. When we consider resource availability, it encompasses not just the quantity but also the quality and efficiency with which those resources are utilized. The increasing productivity of labor and advancements in technology contribute to an economy’s potential output by enhancing how effectively resources are used. As a result, potential output is fundamentally linked to the economy's structural characteristics rather than short-term fluctuations or demand pressures. In contrast, consumer demand and trade cycles influence actual output but do not determine the potential output. Potential output is more stable and reflects long-term economic capabilities, not temporary variations due to economic conditions or demand fluctuations. Therefore, it is correct to assert that potential output is based on resource availability and productivity levels.