Income

Concepts of Income and Their Measurement

Income is especially relevant in comparing different entities over time in various contexts and for different purposes. Thus, many psychological, social, economic, and managerial theories have the central idea of social comparison and use income as one of the main indicators. Today's concepts are mainly based on John Maynard Keynes's first systematic conceptualizing of income comparison in 1936, followed by James Duesenberry's notion on relative income and consumption in 1949, and Richard Easterlin's statement in 1974 that welfare does not depend on absolute but rather on relative income. In 1957, Milton Friedman introduced the concept of permanent income, which is closely related to the concept of welfare.

Income is a key determinant of individual and household consumption patterns. For an individual, the income is the sum of all wages, salaries, interest rates, profits, payments, rents, transfers, and other received earnings. A widely used concept for comparing individuals' or households' welfare is disposable income that consists of earnings, self-employment and capital income and public cash transfers, from which income taxes and social security contributions paid by households are deducted. Comparing households' welfare calls for a definition of the term household itself. Here, different approaches coexist: the household as economic unit, dwelling unit, family, or network (Warner and Hoffmeyer-Zlotnik 2003). Moreover, an equalization of the income is essential to account for the different household sizes and compositions. One of the most widely used scales is the Organization for Economic Co-operation and Development (OECD) weighting scheme that is perpetually adjusted from the old Oxford scale over the modified OECD scale toward the square-root scale. The latter one uses the net income divided by the square roots of the number of household members as equivalence income.

On a societal level, social income is a prominent measure to evaluate and compare countries' welfare. The OECD compares societal incomes, such as the gross domestic product (GDP), which measures the value added in a region—usually a country—by goods and services produced by labor and property or transaction profits. On a per capita basis, it reflects economic welfare or well-being. Purchasing power parities (PPP) equalize incomes and show relatively what the same shopping basket costs in different countries. PPPs are preferable over exchange rates. Converting the GDP via PPP to a common currency and considering the unequal purchasing power of national currencies (price levels) allow for international comparison of economic sizes and welfare.

Application for Discussions on Poverty and Inequality

Income inequality and poverty are highly prominent issues in policy and popular debate. Several income-related measurements are suitable for displaying income inequality and poverty. Two important measures of income inequality are the Lorenz curve and the Gini-coefficient. Whereas the Lorenz curve plots the cumulative shares of the population—from poorest to richest—against the cumulative share of income that they receive, the Gini-coefficient displays the area between the line-of-equality and the Lorenz curve. The values of the Gini-coefficient range between 0 in case of “perfect equality” and 100 in case of “perfect inequality.” Scandinavian countries have a Gini-coefficient of around 25 while the United States had one of 41 in 2007 (United Nations Development Programme 2007/2008).

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