What is potential output in an economy?

Potential output refers to the level of economic output that an economy can produce when operating at full capacity, without leading to inflationary pressures. Option B accurately captures this definition, emphasizing the long-term sustainability of this level of output.

In the context of macroeconomic theory, potential output is essential for policymakers since it serves as a benchmark for assessing the economy's performance. When actual output falls below potential output, it typically indicates underutilization of resources, which may correlate with higher levels of unemployment. Conversely, when actual output exceeds potential output, the economy may experience inflation because demand can outstrip supply.

Considering the other options: The maximum output of goods and services possible, while it may sound appealing, doesn’t account for the inflation aspect and could mislead one into thinking that exceeding this output is feasible without consequences. Output levels that include cyclical unemployment factors do not accurately represent potential output, as potential output is determined by structural and frictional unemployment primarily. Lastly, describing potential output as the absolute peak of production capability in terms of resources does not adequately convey the long-term sustainability aspect, which is critical for understanding the relationship between output and inflation.

Thus, option B encapsulates the concept of potential output by highlighting the importance of sustaining economic output without