CHAPTER 2

- ALTERNATIVE MEASURES OF NATIONAL

INCOME, PRODUCTION FUNCTION,
CONSUMPTION FUNCTION, & INVESTMENT
FUNCTION
Alternative measures of national income
• GNP (Gross National Product)
• NNP (Net National Product)
• NNI (Net National Income)
• PI (Personal Income)
• DI (Disposable Income)
GNP / PNB (Produk Nasional Bruto)
• To obtain gross national product (GNP), we add
receipts of factor income (wages, profit, and rent) from the
rest of the world and subtract payments of factor income
to the rest of the world.

GNP = GDP + (Factor Payments from Abroad -

Factor Payments to Abroad)

• Whereas GDP measures the total income produced

domestically, GNP measures the total income earned by
nationals (residents of a nation).

• GNP includes the final value of goods and services

produced by the residents of a country, without
considering their geographical location.
• GNP = GDP + (Factor Payments from Abroad -
Factor Payments to Abroad)
• Contoh :
• A =nilai produksi WNI di DN
• B= nilai produksi WNA di DN
• C = nilai produksi WNI di LN

• GDP = A + B, GNP = A + C
• atau GNP = GDP + (C-B)
• Misal, A = 100, B = 50, C = 20, GDP = 100 + 50 = 150
• (1) GNP = 100 + 20 = 120
• (2) GNP = 150 + (20-50) = 150 + (-30) = 120

• MNCs (Multinational Cooperations) – Coca Cola, McD,

GDP vs. GNP
• GDP is the sum value of all goods and services
produced within a country.
• GNP is the sum value of all goods and services
produced by permanent residents of a
country regardless of their location.
• GDP of a particular country, production by foreigners
within that country is counted and production by
nationals outside of that country is not counted.
• For GNP, production by foreigners within a
particular country is not counted and production by
nationals outside of that country is counted.
GDP vs. GNP
• GDP is the value of goods and services produced
within a country.
• GNP is the value of goods and services
produced by citizens of a country.
 GDP GNP

Definition: An estimated value of the total GDP (+) total capital gains from
worth of a country’s production and overseas investment (-) income
services, calculated over the course earned by foreign nationals
on one year domestically

Stands for: Gross Domestic Product Gross National Product

Formula for Calculation: GDP = consumption + investment GNP = GDP + NR (Net income
+ (government spending) + from assets abroad (Net Income
(exports − imports) Receipts))

Layman Usage: Total value of products & Services Total value of Goods and Services
produced within the territorial produced by all nationals of a
boundary of a country country (whether within or outside
the country)

Application (Context in which To see the strength of a country’s To see how the nationals of a
these terms are used): local economy country are doing economically
NNP / PNN (Produk Nasional Netto)
• To obtain net national product (NNP), we
subtract the depreciation of capital—the amount
of the economy’s stock of plants, equipment, and
residential structures that wears out during the
year:
NNP = GNP – Depreciation
NNI, PI, DI
• NNI/ Net National Income/ Pendapatan Nasional
Bersih
• = NNP – Indirect Tax

• PI / Personal Income / Pendapatan Perseoranan

• = NNI – (Coorporate Profits + social insurance
payment) + transfer payment

• DI (Disposable Income/ Pendapatan yang siap

dibelanjakan)
• = PI – Direct Tax
The available production technology determines how much output
is produced from given amounts of capital (K) and labor (L).
The production function represents the transformation of inputs
into outputs.

We write the production function as:

Y = F (K,L)

Income is some function of our given inputs

To see an example of a production function–let’s visit Mankiw’s
Bakery…
The kitchen and its The workers hired to The loaves of bread
equipment are Mankiw’s make the bread are its are its output.
Bakery capital. labor.
Mankiw’s Bakery production function shows that the number of loaves
produced depends on the amount of the equipment and the number of
workers. If the production function has constant returns to scale, then
doubling the amount of equipment and the number of workers doubles
the amount of bread produced.
• Constant Return to Scale , K = 1, L = 1, Y = 1
• Decreasing Return to scale, K = 1 , L = 1 Y = -2
• Increasing Return to scale, K =1, L = 1, Y = 2
The goal of the firm is to maximize profit. Profit is revenue minus
cost. Revenue equals P × Y. Costs include both labor and capital
costs. Labor costs equal W × L, the wage multiplied by the amount
of labor L. Capital costs equal R × K, the rental price of capital R times
the amount of capital K.

Profit = Revenue - Labor Costs - Capital Costs

= PY - WL - RK

Then, to see how profit depends on the factors of production, we use

production function Y = F (K, L) to substitute for Y to obtain:

Profit = P × F (K, L) - WL - RK

This equation shows that profit depends on P, W, R, L, and K. The

competitive firm takes the product price and factor prices as given
and chooses the amounts of labor and capital that maximize profit.
The marginal product of labor (MPL) is the extra amount of output the
firm gets from one extra unit of labor, holding the amount of
capital fixed and is expressed using the production function:
MPL = F(K, L + 1) - F(K, L).
Most production functions have the property of
diminishing marginal product: holding the amount of capital
fixed, the marginal product of labor decreases as the amount of labor
increases.
The MPL is the change in output Y
when the labor input is increased
F (K, L)
by 1 unit. As the amount of labor MPL
increases, the production function 1
becomes flatter, indicating MPL
diminishing marginal product.
1
L
 Recall from Chapter 2, we
identified the four components
of GDP:

Y = C + I + G + NX
Investment
Total demand Net exports
is composed spending by
for domestic or net foreign
of businesses and
output (GDP) demand
households
Consumption Government
spending by purchases of goods
households and services
 C
C = C(Y- T)

disposable
depends income
on
consumption Y-T
spending by
households The slope of the consumption function is
the MPC. (autonomous
consumption/Konsumsi Otonom)
The marginal propensity to consume – kecenderungan
mengonsumsi marjinal (MPC) is the amount by which
consumption changes when disposable income (Y - T)
increases by one dollar.
To understand the MPC, consider a shopping scenario. A person
who loves to shop probably has a large MPC, let’s say (.99). This
means that for every extra dollar he or she earns after tax
deductions, he or she spends $.99 of it.
The MPC measures the sensitivity of the change in one variable
(C) with respect to a change in the other variable (Y - T).
 I = I(r)
Investment depends
spending real interest rate
on
The quantity of investment depends on the real interest rate, which
measures the cost of the funds used to finance investment. When
studying the role of interest rates in the economy, economists
distinguish between the nominal interest rate and the real interest rate,
which is especially relevant when the overall level of prices is
changing. The nominal interest rate is the interest rate as usually
reported; it is the rate of interest that investors pay to borrow money.
The real interest rate is the nominal interest rate corrected for the
effects of inflation.
The investment function relates the quantity of investment I to the real
interest rate r. Investment depends on the real interest rate because the
interest rate is the cost of borrowing. The investment function slopes
downward; when the interest rate rises, fewer investment projects are
profitable.
Real
interest
rate, r

Investment function, I(r)

Quantity of investment, I
 We take the level of government spending and
taxes as given. If government purchases equal taxes
minus transfers, then G = T, and the government has a
balanced budget. If G > T, then the government is
running a budget deficit. If G < T,
G=G then the government is running a
budget surplus.
T=T