Income consists of payments of money received by a person during a certain period. Wages or salaries received for work done for an employer are the primary source of income for most people.
Some people have other sources of income. People can receive income from interest payments on savings or investments. Rent payments from tenants provide income to some people who own property. Successful business owners earn income as profits from their business. Some individuals receive regular income from businesses or governments while providing no current services in return. This type of income includes social security payments and pension payments from former employers. Such payments are called transfer payments. The sum of income received by a person from all sources is known as personal income.
Measuring income
Economists have many ways of measuring income. Different calculations of income are useful in describing varying economic situations.
Gross and net income.
The total amount of salary or wages owed to a worker before taxes and other deductions is called gross income. Net income is also known as take home pay. It is the money a worker takes home after taxes and other deductions are withheld from gross income. Among other possible deductions are an employee’s contributions to retirement and medical plans.
Disposable and discretionary income.
Disposable income is the amount of money left from gross income after taxes have been paid. Discretionary income is the money available to a person after paying for such necessities as food and shelter. People spend their discretionary income on such items as entertainment and vacations.
Nominal and real income.
Over time, people’s income often rises. So do the prices of most goods and services. The continual increase in prices throughout a nation’s economy is called inflation. When income rises faster than inflation, people’s purchasing power increases. They are able to buy more goods and services than before. When inflation rises faster than income, on the other hand, people’s purchasing power declines. They are able to buy fewer goods and services than before.
Economists distinguish between nominal income and real income. They use this distinction to determine the effect of changing incomes and prices on purchasing power. The amount in actual dollars (or other monetary unit) of a person’s paycheck is a worker’s nominal income. The purchasing power of that income is an employee’s real income. If, for example, a worker receives a 6 percent pay raise, but inflation is at 2 percent, the worker’s nominal income would rise 6 percent. However, the purchasing power of this larger paycheck—the real income—would increase just 4 percent.
National income and gross domestic product
National income is the sum of all income earned by a country’s citizens in producing goods and services during a year. Thus, national income is closely related to a nation’s total production, or gross domestic product (GDP), but it is calculated differently.
In fact, once certain taxes and the annual depreciation (loss) in value of factories and equipment due to wear and tear are accounted for, economists can show that every dollar’s worth of production creates a dollar of income. This income is then paid to those who provided the economic resources, such as labor and land, used to create that production. Thus, the amount of income people earn in a nation in a year roughly equals the value of goods and services produced. Unless the economy is in a recession, production in most economies rises every year. A recession is a temporary decline in overall business activity. As production increases, so does national income. The link between GDP and national income is critical. For a nation’s income to rise, its annual production must also increase.
Although greater production increases income, some economists and environmentalists warn that greater production also creates a number of problems. For example, increased production causes more pollution and leads to the rapid reduction of natural resources.
Income inequality
Improving a nation’s overall economic circumstances requires its production and income to rise faster than its population. When that happens, there is more income per capita—_that is, for each person. An increase in income per capita often improves a nation’s _standard of living. Standard of living refers to the economic well-being of an individual or a group. See Standard of living .
Sometimes rising income per capita in a nation is not accompanied by noticeable income gains for most people. For example, incomes of the wealthiest people in a nation may rise. At the same time, the incomes of many poor and middle-class people may not. Economists describe such a situation as an increase in income inequality. This rise in the uneven distribution of income does not improve a nation’s overall standard of living.
Income inequality results partly from differences in people’s education, training, ability, and ambition. But other factors also affect some people’s income. These factors include family inheritances, illness, and various forms of discrimination.
Almost all economists believe that a completely equal distribution of income would discourage individual effort. Many governments, however, attempt to redistribute income when the income inequality is considered too extreme. They typically do so by raising taxes on those with higher incomes and increasing assistance to those with lower incomes.
International income comparisons
Economists use per capita income and GDP data, along with other measures, to make rough comparisons of economic living standards across nations. However, per capita income differences between highly developed and developing nations can sometimes exaggerate differences in living conditions. Certain types of production undertaken in poorer nations are less likely to be included in income and GDP estimates than similar types of production in richer countries. For example, food grown in a home garden or clothing sewn at home are rarely included in GDP estimates. Such activities are more common in poorer countries than wealthier ones. Even if measurement problems between wealthy and poorer countries were eliminated, however, differences in per capita income levels among countries around the world would remain large.
