Definition of Personal Income—When Is it Used and How to Calculate it?
Updated · Oct 07, 2022
Personal income is an important indicator of a nation's standard of living and overall economic health. Combined with measures of market prices and consumer spending, it presents an accurate picture of the financial state of individuals in a country.
Below, we discuss the definition of personal income, the uses of this measure, and how to calculate it.
What Is Personal Income?
Personal income is an economic measure of the annual earnings of individuals in a given country. You can calculate it by adding up all sources of income—wages, salaries, dividends, interest payments, and rents.
Is Personal Income the Same as Individual Income?
There is a lot of confusion about the terms "personal income" and "individual income."
Personal income is a measure of the total earnings of individuals in a country. It is a key indicator of a nation's standard of living and economic health.
Individual earnings, on the other hand, are simply the total income earned by a single person. While we can use both terms in everyday speech in this sense, the definition of personal income in economics is different.
What Is the Difference Between National Income and Personal Income?
Here are the three ways to differentiate between personal and national income:
- Personal income is the total income of all individuals in a country. It includes the sum of wages, salaries, interest payments, dividends, and rents.
- Gross national income, on the other hand, is the total income of individuals and businesses in a country.
- Another key difference between personal and gross national income is that the former includes only earnings from within the country. In contrast, the latter encompasses all the country’s wealth, whether it’s generated in it or abroad.
Types of Personal Income
We can classify income in two different ways: based on the sources it comes from and on how it’s measured.
Sources of Personal Income
First, let’s go over the sources of annual individual income.
Earned income is the salary people get for full-time, part-time, or freelance work.
In addition to paychecks from a job, royalties, tips, and commissions also fall under this category.
Portfolio income comes from investments in stocks, bonds, real estate, etc.
People can generate it by realizing a sale on the stock market or from dividends and interest.
Passive income is the earnings you receive without having to do any work. This could come from renting out properties, affiliate marketing, investment in a business without active involvement, etc.
While you put in minimal effort to maintain it, you often need to make a big initial investment.
There are a few other types of personal annual income that aren't included in the categories above. For example:
- Inheritance: Generational money or property people get from their family through a will or as a gift.
- Gambling winnings: Any money won from gambling, whether it's from casino games, lotteries, or sports betting.
- Alimony/child support: Payments that one spouse makes to another after a divorce or that one parent makes to another for the care of their children.
Measures of Personal Income
Next, let’s see the different types of personal annual income we can calculate.
Nominal personal income is the total amount of money earned in a given year before taxes or deductions. This number usually appears on paychecks or W-2 forms.
Although it's not adjusted for inflation, nominal personal income is still a good measure of how well individuals are doing financially.
Disposable income is the sum that's left after taxes. It's also known as "take-home pay."
It’s a great indicator of people’s financial well-being. It encompasses both earned and unearned annual individual income.
Real income is a measure of income adjusted for inflation. It's calculated by dividing nominal personal income by the consumer price index (we explain what that is below).
This number gives a more accurate representation of people's financial standing than the other two. It reflects the changing prices of goods and services.
You can use it to compare the well-being of different groups of people or track the progress of a country's economy.
How to Calculate Personal Income?
There are two ways to calculate personal income.
Following the logic of the definition of personal income, the first one is to add all sources of income individuals received:
PI = Salaries + Interest + Rent + Dividends + Transfer Payments
The other personal income formula is the following:
PI = NI – Income Earned but not Received + Income Received but not Earned
The earned but not received income includes corporate and social security taxes and undistributed profits. The received but not earned category encompasses unemployment, social security, and welfare benefits.
If you want to use the second method, you’ll also need the national income (NI) formula, which is the following:
NI = GDP + Income from Foreign Sources – Money Flowing to Foreign Countries
Usage of the Personal Income Measure
Before we wrap up this article, we'll look at a few examples of how analysis can use personal income as an indicator of economic stability.
Personal Income vs. Personal Consumption Expenditures (PCE)
There are a few different ways to measure economic activity. The Bureau of Economic Analysis looks at personal income, personal consumption expenditures (PCE), and PCE Price Index (PCE PI).
Personal income is used in economics as a measure of how much individuals earn in a given period.
The PCE, on the other hand, is the total amount of money people spend on goods and services. It shows how confident people are in the economy and how much they can afford to spend. Analysts consider it to be a more accurate indicator of economic activity, for that reason.
An even more accurate measure of the economic state of countries, though, is the PCE Price Index. It reveals how the prices of goods and services change over time.
The PCE PI is very similar to the consumer price index (CPI). Analysts use both to measure inflation.
The former uses economic income data from businesses and takes into account the GDP. The CPI relies mainly on household reports. So, although practitioners report CPI is more commonly, PCE PI is more accurate.
Taken together, personal income, PCE, and PCE PI present an accurate picture of a country's economic state. They reveal how much individuals earn and spend and how the prices of goods and services change over time.
Personal Income vs. Disposable Personal Income
Disposable income is a type of personal income used to indicate the economic state of a country. You can calculate the disposable income by subtracting total taxes paid from personal income.
The figure shows how much people are left with to spend after paying taxes. This makes it a good indicator of the standard of living in different countries.
The definition of personal income is the sum of all earnings of individuals in a given country per year.
Economists often use it together with data on consumer spending and inflation rates to inform policy decision-making.
Combined with disposable income, the total income can serve as an indicator of the standard of living of individuals.
With an eye for research, Aleksandra is determined to always get to the bottom of things. If there’s a glitch in the system, she’ll find it and make sure you know about it.