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I've just started studying Macroeconomics and I have a quick doubt about the following problem from Mankiw's Macroeconomics 7th edition, page 81:

  1. Consider how each of the following events is likely to affect real GDP. Do you think the change in real GDP reflects a similar change in economic well-being?

a) A hurricane in Florida forces Disney World to shut down for a month.

According to the solution manual, the answer is that "real GDP falls because Disney does not produce any services while it is closed". However, I wonder if it's not possible that real GDP remains constant in that scenario, for instance, if people decides to spend whatever they were going to spend at Disney on other goods and services? Then, if the fall in Disney's production were fully offset by the increased production of substitutes for Disney's services, could real GDP remain unchanged? Is my reasoning correct? Thanks.

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In theory, yes. If there are perfect** (and mutually exclusive) substitutes, and exactly the same amount of money is spent on those substitutes (and individuals would not have spent that money otherwise), then GDP could remain constant.However, even for extremely simple goods, this is unlikely.

However, the question asks how the events are likely to affect GDP. In practice, there are relatively few true perfect substitutes. If people can't go to Disney world, some may opt for less expensive alternatives, like watching a movie. Another consideration is whether or not Disney is obligated to pay staff during the time (probably not, so now there are people who are making less money and buying fewer things), Disney isn't purchasing food stocks and cute teddy bears for its canteens and games, and a host of other effects. The point is, it is most likely to push GDP down.

In this case, I would say the question kind of implies "all else held constant". The key learning outcome here is "When there is a shock, and firms are forced to cease production temporarily, this negatively impacts GDP." This is the basic principal for first year econ. In later years, you will get into general equilibrium, which deals more with the side-effects of such shocks and aggregate micro-decisions.

** Edit: It is technically not strictly necessary for them to be perfect substitutes (see comments below). But in practice (and in the spirit of the first-year level question), shutting down a whole firm/industry will push GDP down. People are choosing between consumption and savings when deciding how to spend their money, between labor and leisure when deciding how to make their money, and taking away a large source of consumption-based utility is likely to ultimately shift choices away from consumption and towards savings and leisure both of which push down GDP in the current period, though savings generally increases it for t+1 (I am not going to get into trade-deficit effects here). But that is a more complex analysis that isn't really the point of the thought exercise in this particular case. Key learning: External shocks that reduce production generally reduce GDP, all else held constant.

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    $\begingroup$ Surely the substitutes don't need to be perfect? My first choice would be A, my second is B, but A is unexpectedly unavailable so I spend my money on B. That doesn't make A and B perfect substitutes, it's just application of consumer preference to the available goods. $\endgroup$ – Adam Bailey Dec 6 '17 at 15:28
  • $\begingroup$ Good answer. A complementary note: if Disney pays its employees while closed, what happens from an economic point of view is that Disney distributes part of its assets to other agents in the economy. It is a transfer of wealth. $\endgroup$ – Alecos Papadopoulos Dec 6 '17 at 17:37
  • $\begingroup$ @AdamBailey Yes, you are right. They need not be perfect substitutes. But if so, utility would be lower. E.g., If this is a two-good, Cobb-Douglass model, they would be choosing a bundle between "Disney" and "Other". The shock increases the price of Disney to infinity, forcing us into a corner solution with all resources spent on Other. Our utility is lower than it would be, but we still spend our whole resource constraint. That said, people are really choosing between many goods, plus labor-leisure decisions to maximize utility. The net effect is almost certainly negative. $\endgroup$ – Aaron Wolf Dec 7 '17 at 8:13

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