Discretionary income is the amount of a person’s income that is left for saving, spending or investing after paying taxes and paying for private necessities, such as food, clothing, and shelter. Discretionary income includes money spent on luxury items, non-essential goods and services, and vacations. It is vital to note that what qualifies as discretionary income may vary for different individuals and different income levels, as well as over time. For example, a colour television set may be a discretionary purchase for a lower-income family, however, it may be thought of a necessity by a wealthy senior citizen.
Disposable income and Discretionary income are terms often used interchangeably, but they refer to different types of income. Discretionary income is derived from disposable income, which is gross income minus taxes. Disposable income, in other words, it is a person’s take-home pay which is used to meet both essential and non-essential expenses.
Calculating Discretionary Income
Discretionary income is what is left over from disposable income after the income-earner pays for mortgage/rent, food, transportation, insurance, utilities, and other essential costs. For most consumers, discretionary income decreases first when a pay cut happens. For example, if a person makes $5,000 per month after taxes and has $3,000 in essential costs, he has $2,000 in monthly discretionary income. If his paycheck gets cut to $4,000 per month, he can still meet his essential costs but only has $1,000 left over in discretionary income.
An example of Discretionary income
The disposable income in this example would be $80,000 (or gross wages of $100,000 less the taxes of $20,000).
The discretionary income in this example would be $30,000 (or disposable income of $80,000 less all the necessary and basic living expenses of a family or an individual). It is the amount remaining that can be used for saving, non-essential purchases, and investing.
Discretionary income is an important marker of economic health because discretionary income is the first to shrink amid a pay reduction or job loss, businesses that sell discretionary goods tend to suffer the most during economic downturns. Economists use it, along with disposable income, to derive other important economic ratios, such as the marginal propensity to save (MPS), marginal propensity to consume (MPC), and consumer leverage ratios.
Knowing the pertinent facts regarding discretionary income is of vital importance to both business and government as well. Companies are interested in discretionary income levels of consumers in various age brackets, geographic areas, and socioeconomic backgrounds because consumers with larger amounts are more likely to spend their money on the goods and services they provide. The statistics also provide information regarding consumer spending habits that can be helpful in targeting marketing campaigns. although the information alone cannot predict how a particular consumer will choose to spend his or her discretionary income, it can provide useful information to help marketers make sound planning decisions.
Discretionary incomes of individuals in certain age groups are of particular value to business and marketing specialists. For example, people over the age of 50 have half of the total amount of discretionary income in their control, making the 50-plus age category the wealthiest group. Similarly, teen and young adult consumers have considerable sums of discretionary income—and are therefore highly valued by companies—because they are more likely to have their living costs absorbed typically by there parents, and young adults are less likely to be in a position where they have to devote resources to support a family.