Discretionary Income

Reviewed by Sujaini | Updated on Aug 27, 2020

What is a Discretionary Income?

Discretionary income is the amount of money left for an individual to spend or save after paying taxes and for personal needs, such as food, lodging, and clothes. Discretionary income includes money spent on luxury goods, holidays, and non-essential goods and services.

Since discretionary income is the first to decline amid job loss or reduction in wages, companies selling discretionary products continue to suffer the most during economic downturns and recessions.

Analysing Discretionary Income

Discretionary spending is a significant part of a balanced economy. Citizens spend money on such items as travel, movies, and consumer goods only if they have the funds to do so. Many people purchase luxury items using credit cards, but through personal debt is not the same as getting discretionary income.

Difference Between Disposable Income and Discretionary Income

Disposable income and discretionary income are terms that are often used interchangeably but apply to different forms of revenue. Discretionary revenue comes from discretionary income, which is the equivalent of gross income minus tax.

In other words, disposable income is the take-home pay of an individual used to cover major as well as non-essential expenses. Discretionary income is what is left of discretionary income after the wage-earner accounts for rent/hypothecary, housing, lodging, electricity, insurance and other essential expenses. For most customers, when a pay cut happens, disposable income gets drained first.

Economy and Discretionary Income

Discretionary income is a significant predictor of economic health. Along with disposable income, economists use it to derive other critical financial ratios, such as the marginal consumption propensity (MPC), marginal saving propensity (MPS), and market leverage ratios.

Over time, aggregate disposable income rates fluctuate for an economy, usually in line with business-cycle activity. As calculated by the gross domestic product (GDP) or another gross indicator, when economic production is substantial, disposable income levels appear to be also high.