I could have titled this post... "Potential GDP is as labor share does". The idea is that potential GDP and labor share reflect each other when compared to real GDP and capacity utilization respectively.
One thing people must realize is that potential GDP describes the center of the business cycle. (See video below for visual explanations.) It seems most people think potential means the top end of the business cycle, but they would be wrong.
Real GDP moves above and below potential GDP through the business cycle in a certain pattern. I will show in the video that capacity utilization moves the same way around effective labor share.
Equations for the video...
Blue line = Real GDP - potential GDP
Red line = Biz cycle amplitude constant * (capacity utilization - effective labor share)/effective labor share
Business cycle constant is displayed above graph in video. It will be changed to convert the % difference between capacity utilization and effective labor share into GDP billions of 2005 dollars.
Output gap = potential GDP - real GDP
The main idea to takeaway from this post is a big one...
Potential GDP is a reflection of how labor shares in the production of a country. If labor receives a larger share, potential GDP is higher. If labor receives a lower share, potential GDP is lower.
We can understand now why economists are just now figuring out that potential GDP is not so high as they thought, and that the output gap is not so high as they thought. They do not understand the effects of a lower labor share.
I am here to reveal the economic mysteries of labor share of national production.