DISPOSABLE PERSONAL INCOME

Disposable income, also known as disposable personal income (DPI), is the

amount of money that an individual or household has to spend or save after income
taxes have been deducted. A worker’s disposable personal income (DPI) is how much
money they have to spend after subtracting taxes, including income tax, Social Security
tax, and Medicare tax. Individuals can either spend or save disposable personal income.

If you are self-employed, your DPI is your available money after subtracting
self-employment tax and income tax. Self-employment tax goes towards Social Security
and Medicare taxes. Generally, you will make estimated tax payments throughout the
year to cover your tax liabilities. If your small business is incorporated, you are likely
not considered self-employed. Taxes are typically already withheld from your salary, so
you don’t need to pay taxes on your own.

Discretionary income is disposable income minus all payments for necessities,

including a mortgage or rent payment, health insurance, food, and transportation. This
portion of disposable income can be spent at will. Discretionary income is the first to
shrink after a job loss or pay reduction. Businesses that sell discretionary goods, like
jewelry or vacation packages tend to suffer the most during recessions. Their sales are
watched closely by economists for signs of both recession and recovery.

How to calculate disposable personal income?

To calculate your disposable income, you will first need to know what your gross
income is. For an individual, gross income is your total pay, which is the amount of
money you've earned before taxes and other items are deducted. From your gross
income, subtract the income taxes you owe. The amount left represents your disposable
income.

Calculating disposable income is fairly simple. Subtract your tax liability from your
income (e.g., wages, commissions, etc.) to find your DPI.

To get started, use the disposable income formula:

Disposable Personal Income = Personal Income – Personal Income Tax

 The disposable income equation is quite simple to use and calculate. First, we
need to find out the gross income of the individual before any expenses and then
deduct the same gross income by the applicable tax rate. As the taxes cannot be
avoided henceforth it’s a must to deduct the income taxes to arrive at disposable
income figures. Disposable income can be used for paying expenses, bills, and leisure
activities.

Example No. 1

Household income is 100,000.00

Income tax rate of 25% (100,000.00 x .25 = 25,000.00)

The household’s DISPOSABLE INCOME would be 75,000.00

Because 100,000.00 – 25,000.00 = 75,000.00

Example No. 2

Wilson and Wilson’s family earn around monthly Php60,000 and they pay Php5,000 as
monthly federal tax. Based on the above information you are required to calculate the
Personal Disposable Income for the entire year.

Solution

Use below given data for the calculation of disposable income

Gross Salary: 60,000

Federal Taxes: 5,000
First, we need to calculate the yearly gross salary and yearly federal taxes.

Therefore, the calculation of disposable income will be as follows:

= 720,000.00 – 60,000.00

Disposable Income will be:

Disposable Income= 660,000.00

Hence, the disposable income of Wilson and the Wilson family is 660,000.00

The Impact of Disposable Income on the Stock Market

Increase in disposable income leads to increases in stock valuations and,

therefore, increases the overall value of the stock market. Disposable income is defined
as the total amount of household income that's available for spending and saving after
paying income taxes. In theory, a widespread increase in disposable income leads to
increases in stock valuations and, therefore, increases the overall value of the stock
market. Disposable income is defined as the total amount of household income that's
available for spending and saving after paying income taxes.

When disposable income increases, households have more money to either save
or spend, which naturally leads to a growth in consumption. Consumer spending is one
of the most important determinants of demand; it creates the demand that keeps
companies profitable and hiring new workers. 

If manufacturers ramp up their production to meet demand, they create more

jobs. When workers' wages rise, this also creates more spending. An increase in
consumption can increase corporate sales and corporate earnings, thus increasing the
value of individual stocks. This increase in individual share price valuations could then
lead to a market-wide increase in value. This has the potential to create an economic
boom.

The opposite also holds true. If disposable income decreases, households have
less money to spend and save, which then forces consumers to consume less and
become more frugal. This decrease in consumption could then decrease corporate sales
and corporate earnings, decreasing the value of individual stocks. This decrease in
individual share price valuations could then lead to a market-wide decrease in value.
This potentially leads to depression or recession.

Increases in disposable income don't always result in an increase in the value of

the stock market, and vice versa. Sometimes, especially in the wake of a recession and
during a recovery period, although disposable income increases, many consumers
remain frugal and do not use their increase in disposable income to increase
consumption. When this occurs, even an increase in disposable income can lead to
a recession. So, an increase in disposable income doesn't necessarily lead to economic
expansion or growth in the stock market.

Consumer confidence is a statistical measure of consumers' feelings about current

and future economic conditions. When consumer confidence is low, people tend to save
their money, rather than spend it, and this can actually constrain economic growth.

What Is Considered Disposable Income

Disposable income is the amount of money left to spend and save after income
tax has been deducted. Individual consumers can use disposable income to help build
their budget and understand how much money they can allocate to certain expenses.

When your employer does payroll, they include withholdings for federal income
tax, Social Security and Medicare. In some areas, you might also have state and local
income taxes withheld as well.

Once your employer makes these deductions from your income, the amount you
receive is your disposable income. Economists also use disposable income to determine
how much money consumers have to spend and how much they have to save.

Disposable income is total personal income minus personal current taxes. In

national accounts definitions, personal income minus personal current taxes equals
disposable personal income. Discretionary income is disposable income (after-tax
income), minus all payments that are necessary to meet current bills. It is total personal
income after subtracting taxes and minimal survival expenses (such as food, medicine,
rent or mortgage, utilities, insurance, transportation, property maintenance, child
support, etc.) to maintain a certain standard of living. It is the amount of an individual's
income available for spending after the essentials have been taken care of:

Discretionary income = gross income – taxes – all compelled payments (bills)

How disposable income impacts your budget
Your disposable income is the money you have to pay necessary bills
like rent or mortgage, utilities, insurance, car payment, food, clothing, credit card
bills and more. You can take your disposable income and allocate a certain percentage
to certain needs or wants. Doing a spending audit makes it easier to identify areas you
can reduce expenses like streaming services or dining out. In some cases, you might
have to be creative in getting more out of your disposable income. You can reduce
insurance costs by comparing providers to find a better deal or pick up a side hustle to
earn more disposable income.

Disposable income vs. discretionary income

Your disposable income is the money you receive after income taxes are withheld.

Discretionary income takes your disposable income and subtracts all the necessities you
need. It can include your mortgage or rent payment, food, gas, utilities and more. Once
you factor these items into your budget, your discretionary income is the amount of
money remaining you have to save, invest or spend on wants.

● Disposable income is net income. It's the amount left over after taxes.
● Discretionary income is the amount of net income remaining after all necessities
are covered.
● Economists monitor these numbers at a macro level to see how consumers save,
spend, and borrow.
● Shelter, food, and debts are usually paid using disposable income.
 ● The government uses disposable income when deciding how much of a paycheck
to seize for money owed in back taxes or child support.
● A widespread increase in disposable income leads to increases in stock valuations
and, therefore, increases the overall value of the stock market.
● When disposable income increases, households have more money to either save
or spend, which naturally leads to a growth in consumption.

Factors to Consider When Calculating Disposable Income:

● Disposable income can vary from month to month. For instance, if you
look at your expenses for your next pay period and calculate how much is left
over each day, "not every pay period would have the same disposable
income," says Liz Crystal, owner of the LC Group, a daily money
management, personal bookkeeping and consulting services firm in Green
Brook, New Jersey. After all, your expenses won't be the same each pay
period. During the first pay period, you may pay your mortgage and water
bill, and during the second pay period, you may have to cover your car
insurance or student loans. Your variable expenses likely change, too. Not
everyone spends the same amount on groceries from week to week, for
example.

● Savings should be taken into account. Before calculating your disposable

income, Crystal suggests subtracting money for savings, such as your
retirement and emergency fund. It's the "pay yourself first" mantra.
Otherwise, you may end up spending all of your disposable income and
saving nothing.

● Think long term and be realistic. Be careful not to put too much weight
on one number, says Kelan Kline, who runs the finance and lifestyle blog The
Savvy Couple, with his wife Brittany. "The biggest thing to consider when
calculating your disposable income is being realistic with yourself. Just
because your yearly budget says you have an extra 10,000 left at the end of
the year does not mean you should start living like a high roller," he says.
"You need to think long term and understand things like car repairs, taxes, a
death in the family and so on are going to happen at some point."

Why Is Disposable Income Important?

Understanding and calculating disposable income is a key step in preparing a

personal budget since it is the amount you actually have to make spending or saving
decisions. Disposable income is also an important concept for those studying and
planning government economic policies.

The Bureau of Economic Analysis (BEA) reports disposable income as one of

three main measures of income. It’s also part of the government’s calculations of
consumer spending and figures in the consumer price index. Disposable income is also
used to help set Social Security benefits, as well as government transfers such as
unemployment and disability.

Disposable income formula

Disposable income is total personal income minus personal current taxes. In

national accounts definitions, personal income minus personal current taxes
equals disposable personal income
 CONSUMPTION, SAVINGS AND INVESTMENT
Consumption, in economics, the use of goods and services by
households. Consumption is distinct from consumption expenditure, which is the
purchase of goods and services for use by households. Consumption is defined as the
use of goods and services by a household. It is a component in the calculation of
the Gross Domestic Product (GDP). Macroeconomists typically use consumption as a
proxy of the overall economy.

When valuing a business, a financial analyst would look at the consumption trends in
the business’ industry. It is an important step, as it helps the analyst with the
assumption section of the financial model.

► The use of resources.

► It is the money spent on goods and services which yield satisfaction.
► Also called “short-hand” in Keynesian economics.

TYPES OF CONSUMPTION:

1. Direct or Final consumption

2. Indirect or Productive consumption
Theories in Consumption

Keynes identified three factors that affect consumption:

● Disposable income: For most people, the single most powerful determinant of
how much they consume is how much income they have in their take-home pay.
This left-over income is also known as disposable income, which is income after
taxes.
 ● Expected future income: Consumer expectations about future income also are
important in determining consumption. If consumers feel optimistic about the
future, they are more likely to spend and increase overall aggregate demand.
News of recession and troubles in the economy will make them pull back on
consumption.
● Wealth or credit: When households experience a rise in wealth, they may be
willing to consume a higher share of their income and to save less. When the US
stock market rose dramatically in the late 1990s, for example, US rates of saving
declined, probably in part because people felt that their wealth had increased
and there was less need to save. How do people spend beyond their income
when they perceive their wealth increasing? The answer is borrowing. On the
other side, when the US stock market declined about 40% from March 2008 to
March 2009, people felt far greater uncertainty about their economic future, so
rates of saving increased while consumption declined.

Importance of Consumption

Modern economists give a lot of importance to the level of consumption in the economy
because it characterizes the economic system the country currently operates in.

1. The beginning of all economic activity

Consumption is the start of all human economic activity. If a person desires something,
he will take action to satisfy this desire. The result of such an effort is consumption,
which also means the satisfaction of human wants.

2. End of economic activities

If, for example, a person desires a sandwich, they will take the effort to make the
sandwich. Once it is made, the food is consumed, resulting in the end of an economic
activity.

3. Consumption drives production

According to economist Adam Smith, “Consumption is the sole purpose of all

production.” It means that the production of goods and services is dependent on the
level of consumption.

4. Economic theories

The study of consumption theory has helped economists formulate numerous theories
such as the Law of Demand, the Consumer Surplus concept, and the Law of
Diminishing Marginal Utility. These theories help analysts understand how individual
behavior affects the input and output in the economy.

5. Government theories

Consumption habits also help the government formulate theories. The minimum wage
rate and tax rate are determined based on the habits of individuals. It also helps the
government make decisions on the production of essential and non-essential
commodities in a country. It also provides the government with insight into the saving
to spending ratio in the economy.

6. Income and employment theory

Consumption plays an important role in the income and employment theory under
Keynesian economics as put forth by John Maynard Keynes. Keynesian theory states
that if consuming goods and services does not increase the demand for such goods and
services, it leads to a fall in production. A decrease in production means businesses will
lay off workers, resulting in unemployment. Consumption thus helps determine the
income and output in an economy.

Consumption and the Business Cycle

Consumption expenditure in the private sector accounts for two-thirds of the Gross
Domestic Product (GDP). The remaining one-third consists of government expenditure
and net exports. Private consumption is divided into three categories: Durable goods
that are defined as goods with a lifetime greater than three years, services that include
travel and car repairs, and non-durable goods such as food and water that can be
immediately consumed.

The consumption flow and expenditure (consumption expenditure) can help analysts
understand the fluctuations in the business cycle. Producers of durable goods only earn
income from the sale of the initial product (expenditure), not from consuming the goods
following the purchase.

Hence, it is expenditure and not consumption flow that determines short-term economic
prosperity. Due to the nature of durable goods, economists have created a rational
optimization framework to account for the goods. During an economic downturn,
consuming durable goods decreases because the goods require a significant
investment, and consumers will put off the purchases until economic conditions
improve.

When the economy recovers, spending on durable goods increases and becomes more
volatile than spending on non-durable goods. A change in interest rates, tax rates, or
other stimulus measures affects spending on durables more than any other kind of
spending.

States Affecting Consumption

Economists believe affects consumption and your decision to purchase products and
services, besides your real income

•Prices – If prices goes down, consumption will get high

•Taxes – Can earn more Taxes, because public are will to pay taxes
•Income – High income, high consumption
•Saving – Some people save their spending

SAVING

The part of income which is not consumed. To some people, it’s Money in the bank.
To some it’s buying stocks or contributing to a pension plan. But to economists, saving
means only one thing – consuming less out of a given amount of resources in the
present in order to consume more in the future. Saving is not an investment. Saving is
often confused with investing, but they are not the same. Although most people think
of purchases of stocks and bonds as investments, economists use the term investment
to mean additions to the real stock of capital: plants, factories, equipment, and so on.

What people save, avoiding to consume all their income is called personal savings.
Examples: investment like house, real estate, bonds, shares and other financial
instruments. Business savings can be measured by the value of undistributed corporate
profits. Public savings are basically tax revenues less public expenditure. Always invest
in that firm or thing whose rate of return or profitability in future is high.

INVESTMENT

Money committed or property acquired for future income. Investment to mean

additions to the real stock of capital: plants, factories, equipment and so on.

► Fixed investment – spending on new capital machinery and plant, housing,

vehicles, etc.

► Working capital – is spending on stocks/inventories of finished goods and raw

materials.
Types of investment

► Traditional Investment – refers to putting money into well-known assets

► Alternative Investment – include funds, managed futures, real estate,

commodities and properties.

Determinants of Consumption:

1. Wealth - The wealth effect is a behavioral economic theory suggesting

that people spend more as the value of their assets rise. The idea is that
consumers feel more financially secure and confident about their wealth when
their homes or investment portfolios increase in value.
2. Price level - The price of a product is determined by the law of supply and
demand. Consumers have a desire to acquire a product, and producers
manufacture a supply to meet this demand.
3. Consumer Expectations – consumer expectations especially expectations
concerning future income, needs, the price level and the availability of goods and
services – generally have a strong influence on consumer expenditures, the role
of expectations must be carefully considered in formulating a satisfactory theory
of the consumption function.
4. Interest - Higher interest rates are thought to affect consumer spending
through both substitution and income effects. Higher interest rates lower
consumption through the substitution effect, because current consumption
becomes expensive relative to saving--households reduce their spending today in
favor of spending tomorrow.

Consumption Function

Tells the relationship between consumption level of household disposable income. It

is a functional relationship between two aggregates (example: total consumption and
National Income). Consumption is an increasing function of income.

The consumption function or the propensity to consume is not static and there are
various factors influencing it for a change. 

1. Subjective factors

2. Objective factors

Subjective Factors governing consumption function:

The former is called psychological factors by Keynes who lists about eight motives
which lead individual to refrain from spending out of their incomes.

1. To build up a reserve against unforeseen contingencies.

2. To provide for an anticipated future relation between the income and the needs of
the individual or his family different from that which exist at present, as for example, in
relation to old age, family education, or maintenance of dependents.

3. To enjoy interest and appreciation i.e., because a large real consumption at a later
date is preferred to a smaller immediate consumption.

4. To enjoy a gradually increasing expenditure since it gratifies a common instinct to

look forward to a gradually improving standard of life rather than the contrary, even
though the capacity for enjoyment may be diminishing.

5. To enjoy a sense of independence and the power to do things, though without a

clear idea or definite intention of specific action.

6. To secure a masse de manoeuvre (Working Mass) to carry out speculative or

business projects.

7. To bequeath a fortune.

8. To satisfy pure miserliness, i.e., unreasonable, but insistent inhibitions against acts of
expenditure as such.

Objective Factors influencing the consumption function:

The list of factors under this category affecting consumption is a big one and we shall
take up for discussion only very important factors.

1. Money Income

Money income of the individual is the dominant factor in determining his consumption.
Income, consumption and savings of an individual are related to each other.

2. Real Income

Keynes points out that the consumption is influenced by real income than by money
income. A change in the price level will change the value of money and the purchasing
power. Fluctuation in prices will affect real income and also the propensity to consume.
Phenomenal rise in the price level will reduce the real income and so there will be a fall
in the propensity to consume.

3. Distribution of Income

The most important factor determining consumption function is the manner in which
the income or wealth of the community is distributed. Normally the average and
marginal propensities to consume will be higher for poor people than the rich; the
reason being that the former will be living without many essential and basic needs of
life and additional income will be fully made use of in consumption to satisfy basic
wants.

On the other hand, the rich may not be having many unsatisfied wants and hence their
propensity to save will be higher. Statistical studies have proved that a large portion of
investment has come only from the savings of the rich. Consumption will be low when
there are gross inequalities of income in the country. Reduction of inequalities will
increase the propensity to consume in the economy.

4. Fiscal Policy

The fiscal policy of the government relating to taxation, expenditure and public debt will
appreciably affect the propensity to consume. Heavy indirect taxes will leave little
money with the people of low-income groups and their consumption will get depressed.

A reduction in taxes will leave more disposable income which can be used for
consumption. Highly progressive system of taxation will reduce inequalities which will in
turn increase the propensity to consume in the economy.

5. Financial policies of Corporations

If joint-stock companies and corporations adopt a ‘fat dividend’ policy, the disposable

income of the shareholders will be high and consequently the propensity to consume
will also go up.

6. Expectations of future changes

If the people in the economy expect sudden changes in the future regarding their
income, price-level or shortage of commodities or bumper harvest, the consumption
function will change.

During war, shortage of commodities will be expected and the consumers will rush to
buy far in excess of their needs. If they anticipate bumper crop or massive import which
would reduce the prices in the near future, consumption would be postponed to a
future date and hence propensity to consume will become low.
7. Windfall gains and huge losses

Sudden windfall income or gains will increase the consumption function, while huge
losses will reduce the consumption. In the late twenties, the windfall gains in the stock
market of U.S.A., increased the consumption function of the wealthier classes.

8. Liquid Assets

When people have liquid assets, they will be inclined to spend more and the
consumption level will be high. During war periods, increased liquidity due to war
financing will lead to increased consumption.

9. Rate of interest

Views differ regarding the role of interest in consumption function. The classical view is
that if the rate of interest goes up, people will consume less and save more to take
advantage of the higher interest rate. When interest rate falls, they will consume more
and save less. Consumption varies inversely with the rate of interest.
According to Keynes, the effect of rate of interest on consumption and savings is
complex and uncertain.

The short period influence of the interest rate on individual spending out of a given
income is secondary and relatively unimportant, except, perhaps where usually large
changes are in question.

Only in the long period, changes in the rate of interest influence social habits of the
people which in turn affect consumption. Further changes in the rate of interest affect
the purchase of durable consumption goods on installment basis.
A rise in the rate of interest makes the installment purchase more expensive and the
customers arc discouraged to buy goods. A fall in the rate of interest will increase
consumption of goods purchased on installment system.

10. Consumer durable

Consumption expenditure depends on the consumer durable goods available and

demanded in the country. If the country had been enjoying prosperity for a long period,
the people would be possessing many durable goods with them like motor car, sewing
machine, fridge and TV which would serve them for a long time. Hence the people may
not be spending on such items, but would save more out of their disposable incomes.

11. Demographic factors

The consumption expenditure differs from family depending on demographic factors,

though the income may happen to be the same for all families. ‘Large-sized’ families will
spend more than ‘small-sized’ families. Occupation, residence, composition of the family
will determine expenditure.
Normally urban-bred families will spend more than rural families. Farmers and small
businessmen will spend less than professional people. Families having children
attending colleges will be spending more. In short, the propensity to consume depends
on tastes, preferences, standard of living and aptitude and attitude of the people.)

12. Duesenberry Hypothesis

Prof. Duessenberry has made two important observations regarding the factors affecting
the consumption of an individual:

1. The consumption expenditure of the people not only depends on the current level of
income, but also on the standard of living in the past. If income falls, no doubt, the
expenditure will also fall, but not to the same extent, as the people will find it difficult to
adjust their expenditure to changed conditions.

2. Another important factor is what may be called the Demonstration Effect. An

individual’s consumption depends not only on the absolute amount of his income, but
also on its size relative to incomes of others.

For example, the low-income group will try to imitate the consumption standard of
high-income groups. They will purchase fashion goods and costly commodities used by
rich people. But, the moment low-income groups start using these goods consumed by
higher-ups, the latter will avoid consumption of these commodities and go in search of
still better or valuable commodities. This is what is called the Demonstration Effect
which will have mutual reactions resulting in increased consumption function.

Steps to increase consumption function

The fundamental concept of Keynesian employment theory is the ‘Effective Demand‘

which depends on the consumption function of the economy. Though consumption
remains fairly stable in the short period, many factors can be used to step the
consumption function in the long run to achieve full employment.
Since consumption forms the basis of employment creation, it is the duty of
government to aim at the social control of investment and step up investment by
adopting suitable plicies, the following steps will increase the marginal propensity to
consume.

1. Redistribution of Income

We have already studied that distribution of income affects the propensity to consume.
The fiscal policy of the government should aim at redistribution of income by means of
transfer of resources from the rich to the poor so that the income of the poorer classes
would go up. Effective measures in taxation, progressive methods to tax the rich
without affecting capital formation would ensure better redistribution of income and
wealth in the community. With better redistribution of income, the propensity to
consume would increase in the economy.

2. Social Security Schemes

A well-planned system of social security measures would increase the consumption

function in the economy. Unemployment insurance, old-age pension, health insurance,
etc. will help in increasing the productive capacity of the economy and also the
consumption function. These schemes will increase the purchasing power of the people
and the paradox of thrift common to all capitalist economies would vanish. These
measures would help the economy to a great deal during a digressionary period.

3. Wage Policy

Wage policy is a complex problem in the economy and it should aim at increasing the
consumption function without any adverse effects. A cut in wages is not a suitable
practical policy and a rise in wages will increase consumption function. But a mere rise
in wages without increasing the productivity of workers would lead to inflationary
conditions and ultimately to unemployment. The wage policy and productive policy
should go hand in hand to enable the economy to consume more and grow more.

4. Urbanization

Normally, the propensity to consume will be high in urban and industrialized centres
rather than rural areas. A policy of urbanization and starting of urban colonies would
enhance the consumption function.

5. Easy credit and sales promotion

Easy credit facilities and installment schemes will enable the consumers to enhance
their consumption. Similarly, sales promotion techniques, such as advertisement
through press, screen, radio and TV will increase the demand for many durable
commodities and the consumption function of the economy would go up.