In a closed economy, what happens to the present value of GDP (discounted at 5%) following an output shock (decline) of 21% recovered the following year?
A) There is a permanent drop of 1% in the present value of GDP.
B) There is no long-run effect on present value.
C) There is a 1-year drop of 1% in GDP the first year followed by full recovery.
D) There is a downward spiral in real GDP resulting in a permanent drop of 21%.

Question

Quizplus · Accepted Answer

The present value of GDP is the sum of the discounted future values of GDP. An output shock that is recovered the following year will have no long-run effect on the present value of GDP. However, the output shock will cause a one-year drop in GDP in the first year, which will reduce the present value of GDP by 1%.

In a Closed Economy, What Happens to the Present Value