Unit 2 Macro: Revision on Real Disposable Income

Real disposable income (RDI) measures income after taxes and benefits, adjusted for the effects of inflation. It is a guide to the quantity of goods and services that people can buy after the tax and benefit system has adjusted original incomes and we have made allowance for the effect of price changes.

2011 proved to be a tough year for millions of families in the UK as families were hit by a bigger fall in their real disposable income in 2011 than in any other year since 1977. Real disposable income drop by 1.2 per cent last year compared to 2011. To put this change into context this is equivalent to every family having around £430 less to spend in 2011 than it did in 2010. Little wonder that consumer spending remains weak and is set to fall further during 2012.

What lies behind the fall in real disposable incomes?

1/ Rising prices - consumer price inflation has averaged 3.5% per year since 2008

2/ Wage squeeze - for most people, the annual wage rise has been less than inflation and many have had to accept a wage freeze or a cut in nominal terms. A weak economy means that there is less overtime available to boost wages

3/ Rising taxes - a number of taxes have gone up as part of the Coalition’s deficit-reduction strategy including the rise in VAT to 20%, higher air passenger duty and other indirect taxes.

4/ Collapsing interest rates on savings - a key source of income for many people especially older people who have retired

Our focus in this blog is the change in household income. Keep in mind that income is not the same as wealth. The key point is that wages have not kept pace with prices in the last few years. The median salary for a full-time worker in the UK rose 1.4% in 2011 to £26,244, against a headline CPI inflation rate of 5% or higher.

Key terms:

Real wage: The nominal wage adjusted for the effects of inflation

Real income: Nominal income adjusted for the effects of price changes (inflation) and expressed at constant prices

Real disposable income: Income after taxes and benefits, adjusted for the effects of inflation

Wage price spiral: A situation where workers bid for higher wages because they have seen their real income eroded by rising prices. This can lead to a further burst of cost-push inflation in an economy.

Marginal propensity to consume: The proportion of any change in income that is spent rather than saved

Household wealth: The value of assets owned by households – including property, shares, savings and pension fund assets