A Layman's Guide to the U.S. Economy: Demystifying Economic Indicators (Part 2 - Computing the GDP) | Mikesh Shah | Skillshare

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A Layman's Guide to the U.S. Economy: Demystifying Economic Indicators (Part 2 - Computing the GDP)

teacher avatar Mikesh Shah, Director - AltGmX Technology Pvt Ltd

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Lessons in This Class

10 Lessons (57m)
    • 1. 1 GDP Section Intro

    • 2. 2 GDP compute

    • 3. 3 GDP basic definitions

    • 4. 6 GDP Government Spending

    • 5. 4 GDP Households&Firms

    • 6. 5 GDP Savings&Investments

    • 7. 7 GDP Net Exports

    • 8. 8 GDP US Historical Context

    • 9. 9 GDP Growth Rates Computations

    • 10. 10 GDP Quarterly Report

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About This Class

"Understanding Markets" is one of the technical skill talked about by Robert Kiyosaki in his book "Rich Dad, Poor Dad". In order to "understand markets" we need to make the connections between the economy, financial markets and the central bank's monetary policy. The goal of this class is to provide you with the tools necessary to make these connections. By understanding macroeconomic indicators, their impact on financial markets and the reaction of the central bank you will be able to better predict the direction of the economy, inflation and ultimately the financial markets.

In this second part of "A Layman's Guide to the U.S. Economy: Demystifying Economic Indicators" we will compute the Gross Domestic Product of a hypothetical economy, compute the real and nominal GDP, growth rates and understand the Quarterly Gross Domestic Product report published by the US Bureau of Economic Analysis at the Department of Commerce. We will understand the components of GDP - consumption expenditure, gross private investment spending, government spending and net exports. We will study how through the help of a hypothetical economy and an economic map how GDP equates to C+I+G+(EX-IM). Finally we take a closer look at the Quarterly GDP report published by the BEA and using the knowledge gained from part 1, make the connection between the GDP report and the financial markets. 


Meet Your Teacher

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Mikesh Shah

Director - AltGmX Technology Pvt Ltd


Studied Bachelor of Computer Engineering and a MBA from Queen's University Canada. Worked 8 years in the investment banking division trading primarily in the foreign exchange and bond markets. Spent 11 years in Oracle Financial Services Software Ltd as an IT and banking consultant. During the consulting tenure I worked in various projects - implemented the Sarbanes-Oxley Act - internal controls at the IMF in Washington, built trading systems at an investment bank in London for the algorithmic trading desk, implemented a complex core banking software system at banks such as Bank of Montreal, Wells Fargo.

Recently started a gaming applications company AltGmX Technology Pvt. Ltd.

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1. 1 GDP Section Intro: way high on welcome to this section on the gross domestic product. In this section, we will learn what the gross domestic product is, what its components are the various economic entities that contribute to the close domestic product in an economy on the relationship between them, we will also look at how the GDP is computed, the difference between real and nominal GDP and other important concepts such as computing crow treats. By the end of the section, you will have actually computed the real and nominal GDP off a hypothetical economy on understood the importance of each component consumption, investment, government expenditure and net exports in the U. S. Quarterly GDP report published by the Bureau of Economic Analysis. When people talk about growth rates, they say that the economy is booming or shrinking, or we are in recession or the economy is overheating. What they're actually referring to when they talk about the economic growth is Thekla's domestic product. The gross domestic product is the broadest measure off the country's economic activity, and mostly all economic indicators provide information about the gross domestic product. Growth implies that it does not account for appreciation domestic because it includes expenditure on goods and services produced domestically and not by nationals outside the country. It is the entire nation scorecard. It is keenly watched by policymakers, central banks, economists, traders and countless others both domestically and internationally. We see incredible volumes of data every single day in the working world. That gives us some indication off economic activity. You watch financial news on new home sales, beer, old data, inflation, consumer confidence every single day. They are all economic indicators that tell us the story on growth. The U. S quarterly GDP report, which we shall look at in detail published by the Bureau Off Economic Analysis off the Department of Commerce is the single most important indicator tracked by millions of people worldwide, and its consequences are far reaching in the financial markets. Not only do people tracked the GDP off their own country, but other countries as well, and this global economy, if the growth rate in China slows down, it affects us all. So let's begin by actually computing the gross domestic product off a simple hypothetical economy way 2. 2 GDP compute: Let's kickstart our understanding off the gross domestic product by calculating the GDP off a simple hypothetical economy. We see that the simple economy produced only three products in 2013 to 2015 for the sake of simplicity, since the final GDP number produced by economists is a monetary value usually measured in the U. S. Dollar. To facilitate comparisons off GDP across countries and over time even need to compute the monetary value off goods produced in this economy for each year. So therefore, in 2013 a monetary value off Coke produced is 100 units of Coke multiplied by the poor unit price of Coke, which works out to $200. Similarly, you could easily compute the monetary value off the other two products produced in our hypothetical economy. So the number of baseball's produced in 2013 as 500 units on the price per unit is $5. On Hance, the number of baseball's produced in 2013 would be 500 to 5 on similarly for butter, so you would then total the monetary value of Coke plus baseball plus butter produced in 2013 to arrive at the normal cross domestic product. Similarly, you could compute the nominal goal gross domestic product for 2014 and 2015 and since we are multiplying the current year's production by the current year's prices, these values are called nominal values. When we compute the nominal GDP on a yearly basis, we observed that it changes in GDP figure can be attributed to the changes in quantity plus the changes in prices. Since we're more interested in the effects of growth due to changes in production on not inflation, we can fix the prices or hold the prices constant over time. So this is done by using the prices off a base here. In our case, the base here for our hypothetical economy. It is 2013. By fixing the prices to the base year, we have eliminated the impact of rising prices on gross domestic product on now have a measure off the rial economic activity. So to compute the real GDP in 2014 we would multiply the quantity produced in 2014 times the price off the base here, which is 2013 in our example on. Therefore, we get the real GDP. What you would notice is that the in the basis of the real GDP equals the nominal GDP. So likewise for 13 4014 in 2015 you could compute the nominal GDP and real GDP, populate the values, and then we would next see what growth rates are on. We would then understand how growth rates are affected by both the changes and quantity produced by an economy you're on. You're on the changes in prices for those units produced on our year to year basis, so you could pause this video and completely exercise on. Once you're finished, you would have a good understanding off the difference between the nominal GDP vs the real GDP numbers produced. - Now let's understand growth roots. A growth rate is simply the rate of change off. A value on for all purposes can be measured by the difference between the new value minus the old value divided by the old value into 100 to get the percentage growth rate. So in our example, the nominal growth rate for 2014 is 40% but the real growth rate is 0% enhance we can see that the nominal GDP growth rate for 2014 can be entirely attributes did to the price change, as opposed to changes in unit production that's in real terms the growth rate for 2014 0%. Similarly, we can make changes in the value of production and or prices for 2015 to determine the effect of these two variables on growth. So hopefully now we have a tear understanding off how the gross domestic product nominal. Andrea is computed on the effect off prices and unit production on the total gross domestic product number. 3. 3 GDP basic definitions: So far, we have seen how GDP is computed in an economy producing three goods. However, in the real world, with a country producing millions of goods and services, we need to understand how the GDP is computed by statisticians and economists. We therefore need to dive deeper into understanding the components off gross domestic product on the economic entities that are involved in contributing to the gross domestic product of a country. We quickly browsed through some off the basic economic definitions of terms that you would be required to get comfortable with, as you will come across these terms quite frequently while studying how the gross domestic product is computed. We then explain how GDP is computed by starting with a simple to enter the economy, households and forms. We then build on this hypothetical model to a more complex, realistic model by including more entities such as the government on the rest of the world . Let's begin with the concept of clothes was the starts. Those was the stocks. Flows can be thought off as the flow of water into a bucket. On the stock is the bottle of water flows of variables that measure a rate poor time. For example, the number of hours worked per week. Stocks are values at a point in time, for example, total inventories in a forum or the total amount of money in the economy. Next, let's look at capital voices. Investments. Capital is a stock, so capital is a stop of building plants, equipment inventories, residential and non residential buildings and durable goods. Capital repose to existing stock investments are pro chases of capital and hands addition to existing capital or incremental capital. Investments can be for the categorized into inventory, investments or fixed investments. Net investments are investments, minister Appreciation. So investments are flows forces capital which are stop. You know there are three measures of aggregate economic activity by aggregate economic activity, and B. We mean the sum total off economic activity of a country as a whole. This basically means that we can measure gross domestic product, which is the sum total economic activity in any of the three res by the some off the expenditures, which is called the expenditures method orthe e some of incomes or total products produced in an economy. Whichever way you measure gross domestic product, it amounts to the same figure. The most popular method is the expenditures method that aggregates the some off all expenditures by the various economic entities. By economic entities, we mean households, firms, government on the rest of the world. Let's understand what income is income is the total payment made by forms for the receipt off services. These services are provided by households and the services are called factors of production . So households provide forms with labour, land, capital and entrepreneurship so that the firms can produce goods and services. So forms need labor, land, capital and entrepreneurship on in term. They provide households with income income is therefore wages paid for labor interest paid to creditors for capital rent paid for land and profits paid to shareholders. So income is another measure of aggregate economic activity since it is the amount paid for the factors of production that have created the final goods and services. How's ALS provide land, labor, capital and entrepreneurship, two forms that need to produce goods and services? No expenditure is the purchase off final goods and services bought by households, forms, governments and foreigners. The keyboard here is final and not work in progress goods we can measure expenditure by calculating the amount spent in a year in an economy as a whole. Consumer durable goods, new houses bought by households, buildings bought by form's plant and equipment inventory increases, goods and services bought by governments. Imports etcetera. So the expenditures is the second measure off economic activity, aggregate economic activity or a second measure off gross domestic product. The final measure off economic activity is byproduct. So these are the three measures off economic activity, aggregate economic activity or gross domestic product. We now move on to understanding the importance off gross domestic product as an indicator off economic help. Let's quickly understand why we need to measure the gross domestic product as an indicator of economic health when countries enjoy periods of high economic growth as measured by the gross domestic product forms of producing goods and services more rapidly. This increase in production causes incomes to increase and higher incomes implies higher consumption spending, which further increases the demand for goods and services, causing first in turn to produce more. So we see in a high growth environment, jobs a plenty. Financial markets are booming and consumer confidence is high. On the flip side in a slowing economy. When the gross domestic product is low, brooms cut back on production on later cutback alone on employment, jobs become scarce, consumer spending slows down as consumer confidence is low and therefore production of final goods and services reduces further reducing incomes. This increase in unemployment treat is also politically sensitive on bad for financial markets. So this is why the gross domestic product indicator is considered as the mother of all economic indicators in the financial world. The GDP is therefore defined as a measure of living standards. A measure of goods and services that can be bought by Thean comes off all the individuals in an economy. 4. 6 GDP Government Spending: let's add an additional entity to our hypothetical world. The government. The government, like households, consumes goods and services that firms produce but performed two additional tasks. Collecting taxes and paying benefits and subsidies, also called transfer payments. Since the collection of taxes is a monetary flow from household to governments and the transfer payments are a negative flow from the government to households, we can net these two to call it net taxes or simply we call them taxes on can be assumed as taxes less transfer payments. With the addition off the government, we see that now Franz receive consumer expenditure plus investments, plus government spending and payout incomes. Households receive this income and the outflows from house ALS, our savings plus consumer spending plus taxes. The total expenditure in this more complex economy is consumer spending, plus government spending plus investments. 5. 4 GDP Households&Firms: Let's recap on what we have learned so far. We have seen how the gross domestic product is measured in a simple three product economy. However, in a really complex economy with millions of goods and services, the gross domestic product is measured by either the expenditures approach, the incomes approach or the products approach, the most popular being the expenditures approach. In this approach to calculate the gross domestic product, economists and statisticians sum up all the expenditures on final goods and services by the various economic entities. So the economic entities, our house ALS forms, the government and the rest of the world. Household expenditures are called consumer expenditures spending by firms of school investments. Spending by the government is called government expenditures, and the rest of the world's transactions with a country is termed as net exports, which is simply exports minus imports. So we will see in the future lessons that the gross domestic product is simply the sum off these components. These four components that add up to GDP are consumer expenditure, investments, government expenditure and exports minus imports. So this will be our focus for the rest of the section. Now that we've gone through the basic economic definitions and why we need the gross domestic product. As a measure off the economy, we start by understanding the components off GDP. To understand how each is my each one is measured. He will look at aggregate income expenditure and products and see how GDP can be measured and buy one off three ways. So let's start with the country that has a simple economy with only households that consume goods and services and provide the factors of production. So we've seen what factors of production are. We've seen that back to the production are nothing but land, labor, capital and entrepreneurship that house ALS provide two forms. How's ALS consumed goods and services that are produced by firms and they provide the factors of production. Two forms firms produce goods and services that are consumed by households, and they hire factors of production from households. There are two kinds of flows that take place between households and firms. The first kind of riel flows such as thief factors of production, land, labor, capital, entrepreneurship from households to firms and goods and services that forms provide to household. So these aerial flows, the second kind of flows are monetary floats, such as incomes and expenditures on goods and services. When households buy goods and services, it's a monetary flu. When firms provide incomes to households, that's a monetary floor. In a simple economy with two economic entities, we can see that house ALS spent on goods and services that forms, produce and receive incomes for the supply off factors of production two forms. So these incomes are paid to households in the form off wages for labor, rent for land, interest for capital and profits for entrepreneurship. Let's further simplify this hypothetical economy. Let's assume that our hypothetical economy is an agrarian one. A typical income statement off the farm will look like this. This particular farmer receives money worth $1000 worth off fruits and vegetables bought by households and in turn pays out $1000 for the factors of production. Assuming that there are one million farmers in the economy, the national product will be $1000 million. We can see that the aggregate households by $1000 million worth of fruits and vegetables and the aggregate farms have produced $1,008,000 worth of fruit when vegetables. So this floor is called the rial flow Azriel. Things move between the two economic entities in our case house, ALS and farms. The other flow is theme monetary flow, where the household's expenditure on fruits and vegetables is $1000 million and farms make payments to household for the factors of production in the form off wages, rent, interest and profits, which again amounts to $1,008,000 since in our hypothetical economy, there are no savings. All the money earned by household will be spent on the consumption off fruits and vegetables. So therefore, in this to entity closed economy, incomes received by households is entirely spent on goods and services. On therefore, income equals expenditure on the value off the goods and services produced by firms, it's equal to the value of goods and services consumed by household. So we see, therefore, that income equals expenditure and expenditure equals production and therefore income equals expenditure, giggles production. In our country, the income is $1000 million that households earn for that year, so they earned the $1000 million. They spend the entire $1000 million since the journal Savings. They spend the entire $1000 billion on fruits and vegetables, so the expenditure total expenditure in the economy is $1000 million on the total. Production by farmers is $1000 million. Now One might argue that house ALS, in reality save a part off their income and not all is spent on consumption. So let's look at a slightly more realistic world of savings by households and investments by firms. So next we look at our economy becoming a bit more realistic by the addition off savings and investments. 6. 5 GDP Savings&Investments: let's assume in our slightly more realistic world where households now start saving a part off their income, this would mean that only a part of the income that they received goes into consumer expenditure. This also means that now FRANZ receive less off this monetary flow from consumer expenditure and they shell out more in the form of income, therefore forms for short off money. Since consumer expenditure minus income is now negative in order to buy plant and equipment , and additional inventories forms now need to borrow money. This investment can be divided into capital investment or inventory investment, and we have seen the definitions off capital investment and inventory investment before. In the real world, he savings by households goes into the financial markets either into stocks, bonds, deposits and banks. Etcetera firms, on the other hand, need to fund their cash shortfall and hence borrow from the financial markets. This market bear forms borrow and where the house ALS savings flow is called the capital markets. It is the capital markets that link savings and investments. So in the slightly more realistic scenario, with the addition of savings and investments, we see that firms need to borrow for investments to fund the cash shortfall and receive consumer expenditure from household from's payout incomes. So now households receive incomes and failed consumer expenditure plus savings. 7. 7 GDP Net Exports: Lastly, let's bring the rest of the world to make our hypothetical economy close to the real world . The rest of the world is the last economic entity that is required to bring into our hypothetical world to make this as close to a real world as possible domestic firms by imports from the rest of the world in exchange for money and sell exports in exchange for money to the rest of the world, exports minus imports is called net exports. Now, when we look at outflows from firms, we see that forms bay incomes to households, plus they pay for imports. Therefore, the total outflows from firms now becomes incomes plus imports. With exports introduced in our new economy, expenditures now becomes consumer expenditure consumption expenditure plus government expenditure plus incomes plus exports. But since we know that income equals expenditure equals products in our economy, we see that the left hand side of the equation, which is income plus imports, equals C plus G plus I plus e x well, therefore, incomes equals C plus cheap lis I plus X minus. I am the right inside of this equation. CPAs G plus I plus X minus. I am where the X minus I am is net exports is now the total expenditure in our economy. This aggregate expenditure is what we know as the gross domestic product and is a measure off the aggregate economic activity for that year. If the goods and services are measured in current years, prices that it's called the nominal gross domestic product. But if they are adjusted for inflation than its called the real GDP because goods and services are valued at a basis price, you will discuss real versus nominal gross domestic product later in the Inflation chapter . To summarize, we have seen that in our hypothetical world, income equals products equals expenditure and therefore in the real world. The gross domestic product is also measured by either off the three methods and the expenditure approach. The gross domestic product is measured by aggregating consumer expenditure, the sea in the equation, investment spending, the I in the equation, government spending, the G in the equation and net exports. The e x minus. I am in the income approach statisticians at the incomes generated from the factors of production, salaries, interest, rent and profits. Since profits are the net of depreciation and by definition we have seen that gross domestic product doesn't account for the appreciation. Appreciation is added back to the total figure. Lastly, in the products approach, the aggregate is computed by measuring the value of output off each industry on then aggregating, we now understand how GDP is computed and by modeling the real world with our hypothetical world, we understand its components, consumer spending, government spending, investments, exports and imports. This is the foundation off our economic map, to which we will keep referring to in order for us to make the connections between the economic indicator releases, the economic entities, the GBP components and the financial markets. Before we begin with the economic indicators, we first need to understand the historical context off the gross domestic product figure. To understand what high growth, sustainable growth and recession is. We need to know the historical context, off growth, inflation and interest rates, because when any economic data is released, we can look back to see how the central bank had reacted in the past when confronted with similar data. So if sustainable growth had been, say, 3% historically, and if the current data indicates that the growth is far ahead, off 3%. Let's say more towards 4 4.5%. Then we can look back and see how the central bank reacted in the past by either raising interest rates or by any other direct intervention in the foreign exchange markets by looking back in the past, weaken gauge whether they raise interest rates gradually or was it an aggressive intervention? We can also see what other economic factors were during periods of high growth or low growth. So in order to make predictions on the future off economic growth, inflation and interest rates, we need to have this historic context for our country of interest. 8. 8 GDP US Historical Context: way have finally reached our first economic indicator. The quarterly GDP report released by the Bureau Off Economic Analysis B e A for short off the U S. Department of Commons before me deep dive into this report To understand the composition off consumer spending, government expenditure, investments, exports minus imports in the U. S. Economy. We need to understand the historical context off GDP in the country of interest for us, the U. S. Understanding the historical context of GDP to determine what is sustainable GDP and what the reaction off central banks, especially the Federal Reserve Bank, on the financial market. Participants reaction when the gross domestic product breaks out off its threshold levels, improves our ability to predict the future. We will have more confidence off whether the central bank will lower or raise interest rates to preempt a recession or overheating of the economy. We will have a better understanding of how financial market participants react to each economic indicator, driving the markets higher or lower. After we look at the brief history off growth in the US, we deep dive into each of the components off gross domestic product to determine their sub components. We learned that the components off gross domestic product, our consumption expenditure, government spending, investments and net exports. So when we talk about consumption expenditure, we need to know what the composition of consumption is. What exactly are the house ALS spending on in the U. S. Economy and how much are they spending? When we deep dive into consumption spending, we will see that consumption expenditures made up of three sub components durable goods, non durable goods and services. Similarly, we learn about the composition, off investments, government spending and net exports on their rates in the total expenditure number. At the end of the section, you will have a good understanding of the composition off each off the components of GDP. The release dates off the quarterly GDP report and the importance off this economic indicator for the financial markets. Now we look at the historic growth rates in the U. S. Economy and why central banks and policymakers strive to contain growth within a sustainable level. The growth rate on economy will experience can fall under the three phases high growth, sustainable growth and a recession. It is important to understand the historic context of growth in that particular economy in order to classify growth under these three categories. A high growth of, say, 6 to 7% in a highly developed economies such as the U. S. Might not be sustainable unless the economy is just moving out of recession. But it can be the average growth rate in an emerging economies such as India or China. The general consensus is that real growth between 2.5 to 3.5% in the U. S is sustainable without inciting inflationary concerns in countries such as the US during high growth periods, when the economy is expanding at 6 to 7% for example, the demand for goods and services is rapid and puts an upward pressure on prices. Price increases overtake rage increases, dampening consumer spending. Consumers start spending on borrowed money, thereby increasing debt expansion. So high inflation and increased debt spending causes the Federal Reserve Bank to react by increasing interest rates to cool the economy. An increase in interest rates increases borrowing costs for firms, thereby reducing debt expansion and business investments, bringing the economy toe a slower rate. Now the reverse happens during a recession. A recession is defined as two consecutive quarters when the real GDP is negative. In this scenario, the central bank reduces interest rates to boost spending. Lower costs of borrowing for consumers and Corporates induces spending and and investments . Thus, it is usually seen that when the real GDP moves above or below a sustainable growth rate, the central bank uses its monetary tools to bring it back to a sustainable level. 9. 9 GDP Growth Rates Computations: before we start analyzing the components of GDP, let's for us clarify certain basic concepts such as growth rates and the difference between real and nominal GDP. Let's begin with growth rates. As we mentioned earlier, The absolute Judy Bee number, computed by aggregating C G i e x minus I am has no real significant meaning for anyone. It doesn't tell us whether the economy is shrinking or expanding on a year on your or month on month or quarter. On quarter pace is what we need to determine our growth rates in order to predict how the central banks are, market participants would react. So what do we mean by the growth rate? An example off the annualized growth rate is calculated as shown in the Excel sheet. A simple way to think about the growth off a number is to take the difference between the new value and the old value to determine how much that number has grown. Now, in order to find out the percentage growth, we simply divide the difference by the old value. So now the growth is simply new value, minus the old value divided by the old value growth rates are also annualized so that we can make fair comparisons. So basically, we compare apples with apples and not apples with oranges. We can't compare a quarterly growth rate versus a annualized growth fruit. We need to analyze all the rates. So in our example, the growth rate is already an annual number on. We need not analyze this. However, If we had a quarterly figure, we would need to analyze this number in order for us to make comparisons. So in order for us to make it annual, we simply multiply the quarterly growth rate by four since there are 4/4 in a year. So let's look at our example here in 1984 The absolute GDP number off in our hypothetical economy was $1000 million in 1985 this figure job to $800 million. Now this number on an absolute basis is really doesn't tell us much. But if we compare between 1984 and 1985 and we find out the growth rate, we see that the growth rate is the nominal GDP growth rate is negative 20% which means that in current market prices, the gross domestic product has job 20% on a year on your basis between 1986 and 1985. The gross domestic product has gone up on between 19 eighties seven. In 1986 the gross domestic product has increased by another 20% which is a nominal growth rate. So this figure makes more sense to us and to central banks and market participants than an absolute number. Another concept we should understand is the difference between real and nominal GDP. We know that the components off GDP, which are C i g e x minus I am are calculated in current market prices. But since we're in interested in comparing the GDP figure on a year on your bases, we need to deflate this number and we will see how deflation is done. We will see in this example that a change in the GDP growth rate can be attribute ID to two factors. One is thes the changes in the composition off GDP, for example, an increase in consumer spending or to the changes in prices. We will see how these two factors contribute to the GDP growth rate. Both the changes in composition and the changes in prices. So let's assume that let's go back to a hypothetical economy. And let's assume that this hypothetical economy sells only one product, which is a butter. If the consumption of butter in 1984 was, say, 10 million kilograms and the price off butter was a $10 per kilo, then our total consumption would be $100 million and hence are nominal. GDP would be 100 million in that year's prices. Let's zoom in 1985 the consumption increases to 11 million kilograms. However, the price of butter moves up to say, $12 per kilo due to a shortage off milk. Now in 1985 our GDP increases due to consumer expenditure increasing to $132 million now in 1985 our GDP increases due to an increase in consumer expenditure. So consumers have gone from consuming 10 million kilograms off butter to 11 million kilograms of butter, which is an increase in 10%. So consumer spending has increased in 1985 Andi, our GDP has increased due to an increase in consumer expenditure plus an increase in prices to 100 and $32 million since we are measuring GDP and current market prices and we see that our growth rate has gone up by 32% between 1984 and 1985. However, we know that this 32% increase in GDP is an illusion and partly due to the 20% increase in the price of butter. Therefore, we need to deflate this number to bring prices back to a basis price which is theme 19 84th Prices in our case boast deflation. We can see that the rial GDP now represents a true picture off growth in our hypothetical economy. We can now see how much of the GDP growth is due to a real increase and what is the nominal increase in GDP? We shall study more about these deflator Zoff GDP in the inflation chapter, specifically the to deflate ear's that are estimated in the quarterly GDP release by the Commerce Department, which are the implicit price deflator on the fixed price deflator. But for now, it's important to understand the difference between real and nominal GDP as thes terms will be used throughout. So the action item for this lesson would be to complete the yellow spaces where we need to compute the rial close domestic product. The nominal growth rate on the real growth read Andi for the 1984 1985 year similarly computer growth rate, the real GDP and the rial GDP growth rate for the exercise here, we just need to compute the quarterly growth rate on Analyze that the solution is given in the next worksheet, so you could complete the exercise and check full solution and the next worksheet. By doing this exercise you should be you should get familiar with computing the growth rates, quarterly growth rates on annualized growth rates on get familiar with the concepts off nominal GDP and real GDP. 10. 10 GDP Quarterly Report: now let's dive deeper into the largest component off gross domestic product consumption. This is the most important sector off the economy since it represents over 60% off the gross domestic product. Since consumption is such a large component off gross domestic product, all economic policy makers worldwide focus their efforts to boost consumer spending. Total personal consumption spending itself can be segregated into spending on goods and services. Spending on goods can be further categorized into spending on durable goods on nondurable goods. Durable goods are defined as goods expected to last over three years, so examples off typical durable goods would be cars, furniture cycles. Examples off nondurable goods would be food, drinks, medicines. Anything that is expected to last under three years is nondurable goods. Services would include banking, tourism, healthcare, etcetera. The consumption off services accounts for a majority of thes spending close to 50%. We will see later that there are three economic indicators that give us enough information on consumption trends before the quarterly GDP report is released. So these three economic indicators are car sales, retail sales and personal consumption expenditures. Investment expenditure are those made by corporations as well as individuals and can be classified as fixed investments and change in inventories. Now fixed investments can be further categorized into non residential and residential investments. Non residential investments comprise off spending on plants and equipments. Example and auto company buys a plant and machinery, so that's non residential investments. Residential investments in the US are basically spendings on single family and multi family homes. A smaller but important component off investments is the change in inventories. If inventories increase in that year, they are added to the gross domestic product and if they decrease their subtracted from the gross domestic product. This is because inventory increases are basically goods produced in that year by Corporates but not sold since they were producing that year. They must be added to the GDP figure. Inventory decreases our goods consumed in that current year, but produced in the prior year and hence is since they were not produced in the current year, they must be subtracted from the gross domestic product. We will see later that there are some key economic indicators that give us more information on inventory spending and investments such as housing starts, new home sales, factory orders, etcetera now Let's look at government expenditure. The government spends money on defense, Hi res schools, hospitals, interest payments and many other categories and accounts for roughly 20% off The total gross domestic product in the U. S. Spending can be further divided into federal, state and local levels of spending. Federal spending accounts for the largest of the three. We see that federal spending accounted for roughly half off the total government expenditure in the US We will see one economic indicator that gives us an indication off government expenditure. This is the construction spending report. The last component of the gross domestic product is net exports, which we know is exports minus imports. Exports are added to the gross domestic product as their goods produced domestically on imports are subtracted as there they are goods produced internationally but procured domestically. When the country's exports are less than the imports, the country is said to have a trade deficit. The trade balance also includes services and invisibles such as freight insurance, etcetera. The US runs a massive trade deficit with the rest of the world. We shall see more off this component in the trade balance report in detail. Another important information we need to remember is that the Bureau of Economic Analysis, Thebe a off the Department of Commerce releases three separate estimates off the quarterly GDP on three different dates. So the three separate reports are the Advanced report preliminary report on the revised estimates. The first report is the advance estimates, which is released in the first month off the following quarter. So the first report for Q one is released in April. This report is incomplete and subject to large revisions. The next two reports are the preliminary on the revised estimate reports, which are basically revisions off. The advanced report on these revisions can be quite substantial. Lastly, let's see the effect of growth on the three markets. The bond markets like slow growth when growth is sluggish and inflation is low. The chances off the Federal Reserve Bank lowering interest rates are very high, as we have seen in the earlier lessons that a decrease in interest rates cause bond prices to increase enhance used to fall. Therefore, a sluggish growth rate is good for the bond markets. On the other hand, a high growth high inflation economy is bad for bonds as interest rates are sure to move north, causing bond prices to move south. Slow growth is generally not good for the stock markets. This is because the consumer demand is low and hands puts pressure on corporate profits. However, if expectations on growth improved and interest rates are very low than the stock market could see, a reversal and prices could move higher. Sluggish growth and low interest rate periods are not good for the domestic currency. There is usually a flight off money to countries with higher interest rates. As a final project, you could complete thes spreadsheet on the 2014 GDP components and their sub components. This will give you a good idea on the weights off each component and its sub components, so that when we move forward to studying the economic indicators in detail, you will be able to relate to rich, component and sub component. That indicator is providing us information on this brings us to the end off the gross domestic product topic. We're now in a position to comprehend how the gross domestic product is calculated in an economy. What are the components off GDP on the composition of each component we now understand how growth rates are calculated, the difference between real and nominal gross domestic product, the historical context of growth in the U. S. Economy and the reaction off the central bank and financial markets to the quarterly GDP report way.