Q3. Define potential GDP and explain its determinants. What are the factors that have been inhibiting India from realising its potential GDP?

Model Answer:

Introduction

Potential GDP represents the maximum level of output an economy can achieve without triggering inflation, assuming that all resources—labour, capital, and technology—are fully utilised in a sustainable manner. It serves as a benchmark for assessing an economy's performance, indicating whether it is operating below or above its optimal capacity.

Body

Determinants of Potential GDP

  1. Labor Force: The size and quality of the labour force, including factors like population growth, labour participation rate, and education levels, directly impact potential GDP. A larger, more skilled workforce can produce more goods and services, raising the economy's potential output.
  2. Capital Stock: The accumulation of physical capital, such as machinery, infrastructure, and technology, is vital for production. Investments in capital stock enhance productivity, enabling higher output levels.
  3. Technological Progress: Innovations and technological advancements improve productivity by enabling more efficient production processes. Technological progress can significantly boost potential GDP by making existing resources more productive.
  4. Natural Resources: The availability and efficient utilisation of natural resources like land, minerals, and energy sources contribute to an economy's productive capacity.

Factors Inhibiting India from Realising Its Potential GDP

  1. Labour Market Inefficiencies: Despite having a large and youthful population, India's labour market suffers from inefficiencies such as low labour force participation, skill mismatches, and high levels of informal employment. The lack of adequate job creation, particularly in the formal sector, has hindered the full utilisation of the labour force.
  2. Infrastructure Deficiencies: Inadequate infrastructure, including transportation, energy, and communication networks, has constrained economic activities and increased the cost of doing business in India. These deficiencies limit productivity growth and deter investments.
  3. Slow Technological Adoption: While India has made strides in technology, especially in information technology, the adoption of advanced technologies across sectors remains uneven. The slow pace of technological adoption in agriculture, manufacturing, and other key sectors has restricted productivity improvements.
  4. Structural Bottlenecks: The Indian economy faces several structural challenges, such as land acquisition issues, labour law rigidity, and a complex tax system. These bottlenecks reduce the efficiency of resource allocation and impede the potential growth of the economy.
  5. Environmental Constraints: Environmental degradation and resource depletion pose significant challenges to sustainable economic growth in India. The over-exploitation of natural resources, coupled with inadequate environmental regulations, threatens long-term economic stability.

Conclusion

By implementing effective reforms in these areas, India can enhance its productive capacity and sustain high levels of economic growth in the future. Continuous monitoring of the output gap and potential GDP trends will be crucial for policymakers to steer the economy toward its full potential. 

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