productivity are at their “potential” levels. The output gap (capacity utilisation) is calculated as
the ratio1 between the potential and actual levels of output.
Finally, a clear distinction should be made between capacity utilisation, measuring the actual
relative to potential output (gross domestic product) and excess demand, measuring gross
domestic expenditure relative to actual gross domestic product. The latter influences consumer
prices and is related to the business cycle, which captures movements in aggregate demand in
relation to a slowly adjusting level of aggregate supply.
3. ESTIMATING POTENTIAL OUTPUT AND CAPACITY UTILISATION
The methodology
The particular concept of potential output selected for the purpose of modelling the supply-side
of the South African economy, refers to the maximum level of output that is consistent with
stable inflation. Capacity utilisation is therefore defined as the ratio between actual production
(production function-based) and potential, not normal output, incorporating the role of the non-
accelerating wage rate of unemployment (NAWRU). This particular concept was chosen in line
with the emphasis on the labour market and the control of inflation as a key medium-term
priority. In addition, its use ensures consistency between labour market equilibrium and product
market equilibrium in the supply-side model.
The analytical framework
The estimation of potential output for South Africa is based on a structural production-function
relationship, with the maximum level of output consistent with stable inflation. The level of
unemployment and its associated non-accelerating wage rate are incorporated in the estimation of
potential employment. This approach was adopted from the OECD (Torres, et al. 1989 and
Giorno, et al. 1995).
Capacity utilisation or output gap is determined as the difference between potential and actual
output if the logarithmic forms of the variables are used.