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Disposable Income Formula
What is Disposable Income?
Disposable income is the money that is left over from the salary after one has paid central, state, and local taxes. It is also called disposable personal income (DPI). These three categories of taxes consist of income and wealth taxes and salary deductions for provident funds, retirement funds, and other costs.
The taxes for permits, licenses and other fixed fees someone pays to a government agency at any level are also deducted from personal income to calculate disposable income. If someone has any funds that are withheld for retirement savings that are, as mentioned above, made mandatory by a government, these are also deducted. For most people, taxes mainly represent the greatest component of the subtracted amount.
Disposable income shows the net income an individual gets.
It also tells about the goods and services the consumers can buy over a certain period at different prices. People spend money from disposable income to buy goods and services which helps in determining the specific amount of disposable income to be spent on the purchase of goods and services.
It also Indicates how much of the total disposable income an individual is saving after all of his expenditures.
The spending decisions are always taken spending on current income. Therefore, the effect of spending can be seen on the national GDP in the form of fluctuations.
It can have an effect on the growth of the GDP as well. During an economic crisis, spending will reduce and that can have a direct impact on the growth of the economy too.
Disposable Personal Income Formula
Disposable income can be calculated using the following formula −
Disposable Personal Income = Personal Income-Personal Tax Liability
Personal Disposable Income Formula = Personal Income- Personal Income Taxes
Here is an example of how to find disposable income.
Suppose the gross income of an individual is Rs. 10,00,000 and the direct tax is Rs. 60,000.
Let’s Calculate the Disposable Income -
Gross Income = Rs. 10,00,000
Direct Tax = Rs. 60,000
Disposable Income = Personal Income – Personal Income Taxes
Disposable Income = 10,00,000 – 60,000
= Rs. 9,40,000/-
Importance of Disposable Income
Disposable income can be used for measuring household expenditure for a nation and it has important economic significance.
It is not only a major determinant of consumer spending, but it is also a significant determinant out of the five determinants of demand.
The actual figure of how much disposable income an individual or a population of people has can help economists calculate how much money they might spend on commodities and services.
Moreover, it will also offer insight into how much the population is going to save.
The COVID-19 pandemic of 2020 and 2021 impacted DPI and PCE negatively, but these figures began to recover in late 2021. Both personal income and DPI in India increased in late 2021.
Personal income is the aggregate income collected by, or on behalf of, all Indian residents using any source of income, both domestic and global. However, personal income does not include capital gains (realized or unrealized) or losses arising out of investments. Indian personal consumption expenditure (PCE) is the value of all commodities and services bought by, or on the behalf of, Indian residents and represents an important milestone of the economy's strength.
Real Disposable Income Formula
Real disposable income includes analyzing the purchasing power of individuals after paying all the taxes as well as getting the benefits.
It can be calculated using the following formula −
Real Disposable Income = Personal - Taxes + Benefits
Discretionary income is what is left of one’s disposable income after he has paid for the day-to-day necessities like housing in the form of rent or mortgage payment, food, electricity, healthcare, and transportation.
Discretionary income is the income that can be spent on restaurant meals, travel, entertainment, investments, and any other non-essential items or services.
The discretionary income is the "fun money" to spend on things one doesn’t really need after one’s essential expenses are covered. One can also choose to save a lot of or only a little of the discretionary income.
It is important to note that disposable income is more essential income than discretionary income. As mentioned above, discretionary income is the money used for unnecessary activities that are not absolutely essential for individuals.
However, people often choose to engage in discretionary income when their income exceeds a certain limit. As discretionary income is fun money, it is hard to guess the total expenditures of a population on it.
So, unlike disposable income, discretionary income cannot be exactly accounted for as the disposable income of a population.
Disposable income is a solid indicator of the well-being of an economy. Usually, rising disposable income is an indicator of a developing economy. As disposable income goes up, people make more purchases and this increases the demand in the economy. This, in turn, helps the economy run at a great speed.
The disposable income formula is used to calculate the disposable income of people which shows the extra money one has that can be spent on necessities other than mandatory expenses. This is helpful in determining the aggregate disposable income which is an indicator of demand in the markets. By gauging the disposable incomes, therefore, economists can derive the levels of demand in an economy.
Q1. What is meant by Indian Personal Income (PI) and Personal Consumption Expenditure?
Ans. Personal income is the aggregate income collected by, or on behalf of, all Indian residents using any source of income, both domestic and global. However, personal income does not include capital gains (realized or unrealized) or losses arising out of investments. Indian personal consumption expenditure (PCE) is the value of all commodities and services bought by, or on the behalf of, Indian residents and represents an important milestone of the economy's strength.
Q2. What is the effect of the economic crisis on discretionary income?
Ans. When an economic crisis occurs, discretionary income decreases, and people's savings rate increases. Therefore, disposable personal income, or DPI is an important indicator in analyzing economic situations too.
Q3. What is the full form of PCE?
Ans. PCE stands for personal consumption expenditure.
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