AS Macro Key Term: Real Disposable Income

Disposable income is personal income that remains after direct taxes and government charges have been paid. Real disposable income is the post tax and benefit income available to households after an adjustment has been made for price changes.

Changes in real disposable income are thought to have a strong relationship over time with the level of consumer spending on goods and services. The Keynesian theory of consumption focused on this link between current real disposable income and household spending and saving. But keep in mind that expectations of future changes in post tax and benefit income also have a role in determining spending levels.

Real disposable incomes in the UK have been falling over the last two years. Research from the Centre for Economic and Business Research published in April 2011 found that real household disposable incomes were set by fall by 2.0% in 2011 following an 0.8% fall in 2010.

If these figures are confirmed, the UK will be seeing a bigger fall in real household disposable incomes than in the 1930s and the biggest fall excluding WW2 and the General Strike since 19211. This means that households will have £27.3 billion less spending power in 2011 than in 2009 – a fall of £910 per household.

Real incomes fall when nominal wages and earnings rise less quickly than consumer prices - see the chart below.

Disposable incomes take a hit when the overall burden of taxation rises (e.g. the increase in national insurance contributions and the hike in VAT to 20%) and also when the real value of state welfare benefits and eligibility to claim is cut. The main squeeze on household incomes comes from a higher rate of inflation with wages not keeping pace. Hundreds of thousands of people in the UK have either had to accept a pay freeze or an actual wage cut. Many more have seen their nominal wages or salaries rise by less than the published rate of inflation.

Real household disposable income in the UK

Data from Timetric.

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HN: Real households disposable income: CVM SA : quarterly from Timetric

Guardian: Real household disposable income falls for the first time in 30 years