What does potential GDP signify in an economy?

Potential GDP signifies the maximum output an economy can produce when its resources, including labor and capital, are utilized efficiently. This concept reflects the economy's optimal capacity without leading to inflationary pressures, as it assumes full employment of all available resources in a sustainable manner. It represents a long-term measure of growth and is crucial for understanding the limits of economic production.

In contrast, the other options do not accurately capture the essence of potential GDP. The average output over time does not account for the efficiency of resource use and may include periods of economic downturn or inefficiency. The output during a recession typically falls below potential GDP, reflecting a situation where resources are underutilized. Lastly, output levels associated with high inflation often exceed potential GDP temporarily but are not sustainable in the long term, as they typically indicate an economy operating beyond its productive capacity.