• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

Penpoin.

Better Knowledge. Your Insight Is Sharper

  • Business
    • Business and Strategy
    • Marketing
    • Operation
    • Human Resources
  • Finance
    • Financial Analysis
    • Investment
  • Economics
    • Introduction to Economics
    • Microeconomics
    • Macroeconomics
  • Online Learning
    • Coursera
    • Udacity
    • Udemy
    • Skillshare
    • Magoosh
  • Reading List
    • Self-Help
    • Business and Money
You are here: Home / Macroeconomics / Disposable Income: Meaning, How to Calculate, Impacts, Factors

Disposable Income: Meaning, How to Calculate, Impacts, Factors

Updated on April 15, 2022 by Ahmad Nasrudin

Disposable Income Meaning How to Calculate Impacts Factors

What’s it: Disposable income is the money you have left after paying taxes. You can use it for savings or buy goods and services.

Disposable income is essential to describe household purchasing power. When it increases, we expect households to increase spending. Increased spending stimulates businesses to increase production and recruit workers. As a result, the economy is growing, the unemployment rate is falling, and the outlook for household income is improving.

From OECD data, the United States ranks first in the country with the highest disposable income per capita in 2018 with $53,123. There are Luxembourg ($47,139) and Switzerland ($41,561) in second and third place.

Household disposable income per capita 2018
Household disposable income per capita 2018. Source: OECD, diakses pada 18 November 2020

Calculate disposable income

Disposable income consists of your various income after deducting taxes. Income can come from salaries, capital gains, stock dividends, bond coupons, and government transfer payments. You will not spend your income because you have to pay taxes.

You can then use the remaining money for whatever you need. You can use it to buy products to meet your needs and desires. You can save it and allocate it to various financial instruments such as stocks and mutual funds.

Mathematically, the disposable income formula is as follows:

Disposable income = Total income – Personal taxes

As a simple example, assume your income is $100. The government collects an income tax of around 20%.

Applying the formula above, your disposable income is $80 = $100 – (20% x $100). It is available for you to shop or tube.

The difference between disposable income and discretionary income

Disposable income only considers taxes a deduction because it is a mandatory expense for you as a citizen. However, you may also have other fixed expenses that cannot be deferred, such as a mortgage, utilities, and other basic necessities. They represent the cost of living, which if you don’t pay, you will be fined or impact the quality of your health or life.

We call the money left after paying these fixed expenses as discretionary income. It represents the money left after you have met all of your everyday needs. You can use it to meet other secondary needs.

In a mathematical equation, we can write a discretionary income formula as follows:

Discretionary income = Total income – Personal taxes – Fixed expenses = Disposable income – Fixed expenses

As a note, we only put personal taxes as a deduction for income. It excludes other indirect taxes, such as sales tax and value-added tax (VAT).

Indeed, an increase in indirect taxes can reduce purchasing power. However, it is difficult for us to trace the effect of indirect taxes on each individual.

Why disposable income matters

Disposable income is the primary indicator of household purchasing power and consumption. The changes affect the demand for goods and services and economic activity in various countries. Household expenditures comprise a significant share of gross domestic product (GDP). In fact, in some countries, it contributes more than 50% of GDP.

Economists use disposable income to identify trends in household saving and consumption. When disposable income rises, we expect the demand for goods and services to also increase. That will stimulate the business sector to increase production and recruit more workers. As a result, economic growth (measured in real GDP) increases, and the unemployment rate decreases.

Typically, economists also observe trends in the Consumer Price Index (CPI), a measure of the increase in the price of products purchased by consumers. If the CPI inflation trend is also low, households’ purchasing power for goods and services will be stronger. Thus, it will amplify its impact on aggregate demand and economic growth.

How significant is the impact of household consumption on economic growth?

It depends on the marginal propensity to consume (MPC).

MPC is the extra disposable income that households spend. The higher the MPC, the greater the effect of consumption on the economy. For example, suppose country A has an MPC of 0.75 and Country B has an MPC of 0.50. Suppose disposable income in both countries increases by an equal percentage. In that case, the impact will be more significant for Country A than for Country B.

Economists call this effect a fiscal multiplier. They formulate it as follows:

Multiplier = 1 / [1-MPC (1-t)]

Where t is the tax rate.

A decrease in taxes increases disposable income. It magnifies the effect of household consumption on the economy. Say, the tax rate in both countries falls to 17%. Using the formula, we can calculate the multiplier effect in the two countries as follows:

  • Country A = 1 / [1-0.75 (1-0.17)] = 2.65 times the increase in aggregate output

Country B = 1 / [1-0.50 (1-0.17)] = 1.71 times the increase in aggregate output

Factors affecting disposable income

From the formula, you can see, two main factors influence disposable income: taxes and nominal income. It increases when:

  • Personal tax rate cut
  • Nominal income increases

When the government lowers the tax rate, households have more money to spend on goods and services. It is usually when the government runs an expansionary fiscal policy. The tax cut aims to stimulate economic growth during a recession.

Meanwhile, many factors affect the nominal income, depending on the types of income. But, generally speaking, it happens during a prosperous economy. Strong economic growth brings more income to households.

During this period, the salary and employment outlook improves. Business profits are also growing, allowing the company to pay more dividends. Higher profits also push up their share prices, allowing households to earn more income from capital gains.

Topic: Disposable Income, Fiscal Multiplier Category: Macroeconomics

AFFILIATE

If you click on this link, thank you for contributing to us. We may earn a commission when you buy through our links. Learn more ›

5 NEW ARTICLES

How to Handle and Resolve Stakeholder Conflicts

How to Handle and Resolve Stakeholder Conflicts

Stakeholders have different interests and goals, which are often contradictory. Stakeholder

What are the Benefits of International Trade

What are the Benefits of International Trade?

Increased access to cheaper and more varied goods and services is key benefits of international

Where Do Comparative Advantages Come From

Where Do Comparative Advantages Come From?

The comparative advantage stems from the ability to produce goods and services at low opportunity

What is the Capital Budgeting Process

What is the Capital Budgeting Process?

In simple terms, the capital budgeting process involves generating ideas, making proposals about

Autarky Examples, Pros, and Cons

Autarky: Examples, Pros, and Cons

What's it: Autarky is a system or philosophy in which an economy seeks to

Primary Sidebar

  • "Can't Hurt Me" by David Goggins
    "Can't Hurt Me" by David Goggins
  • "$100M Offers" by Alex Hormozi
    "$100M Offers" by Alex Hormozi
  • "How to Day Trade for a Living" by Andrew Aziz
    "How to Day Trade for a Living" by Andrew Aziz

Footer

5 TRENDING ARTICLES

  • Business Size: Definition, Measurement, Classification
  • Socio-cultural Factors: Examples and How They Impact Business
  • The Role of Business in Society and the Economy
  • List of Examples of Social Enterprises You May Be Familiar
  • Top-Level Management: Examples, Roles and Responsibilities, Skills

EXPLORE MORE

CATEGORIES

Accounting and Finance Books Business and Strategy Financial Analysis Human Resources Investment Macroeconomics Marketing Microeconomics Operation

TOPICS

Aggregate Demand Business Management Demand Financial Analysis Financial Ratio Government Budget International Trade Leadership Macroeconomic Equilibrium Marketing Marketing Management Organizational Structure Profitability Ratio

Copyright © 2023 · About Us  · Privacy Policy and Disclaimer  ·  Affiliate Disclaimer  ·  Terms of Use  ·  Comment Policy  ·  Contact Us