Income - Misplaced Pages

This is an old revision of this page, as edited by Riccardov~enwiki (talk | contribs) at 09:28, 28 August 2006 (+it). The present address (URL) is a permanent link to this revision, which may differ significantly from the current revision.

Revision as of 09:28, 28 August 2006 by Riccardov~enwiki (talk | contribs) (+it)(diff) ← Previous revision | Latest revision (diff) | Newer revision → (diff)

Income, generally defined, is the money that is received as a result of the normal business activities of an individual or a business. For example, for individuals income usually means the gross amount on their payslips, i.e. amount before any tax and other deductions has been made by their employer.

Internationally, the accounting term income is synonymous to term revenue. One of the best accounting definitions of income is the one used by International Accounting Standards Board (quotation from IFRS Framework):

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

Meaning within U.S. accountancy

In U.S. business and accounting, however, income most often means the amount of money that a company earns after paying for all its costs. Outside the U.S., the term is usually profit or earnings. To calculate a company's income, it starts with its amount of revenue, deducts all costs, including such things as employees' salaries and depreciation, and the number that results is its income, which may be a negative number. This money is typically reinvested in the business, paid in corporate tax and used to pay the owners (the shareholders) a dividend.

All public companies are required to provide financial statements on a quarterly basis. The statement of income is an important part of this. Some companies also provide a more rosy financial report of their income, with pro forma reporting, or, EBITDA reporting. Pro forma income is an estimate of how much the company would have earned without including the negative effect of exceptional "one-time events", supposedly in order to show investors how much money the company would have made under normal circumstances if these exceptional, one-time events had not occurred. Critics charge that, in most cases, the "one-time events" are normal business events, such as an acquisition of another company or a write off of a cancelled project or division, and that pro forma reporting is an attempt to mislead investors by painting a rosy financial picture. Besides that, when discussing results with analysts and shareholders, CEOs and CFOs have a tendency to do even more "hypothetical accounting". EBITDA stands for "earnings before interest, taxes, depreciation, and amortisation", and is also criticised for being an attempt to mislead investors. Warren Buffett has criticised EBITDA reporting, famously asking, "Does management think the tooth fairy pays for capital expenditures?"

It is common for some other companies, such as real estate investment trusts, to present reports using a standard called FFO, or "Funds From Operations". Like EBITDA reporting, FFO ignores depreciation and amortization. This is widely accepted in the industry, as real estate values tend to increase rather than decrease over time, and many data sites report earnings per share data using FFO.

Meaning within economic science

In Economics, income is the constraint to unlimited consumer purchases. Consumers can purchase a limited number of goods represented by their "budget constraint". The basic equation for this is Y = Px × x + Py × y, where Px is the price of good x, x is the quantity of good x, and Y is the income (Py and y are similar to Px and x). If you need to examine more than two goods, you can add more on. This equation tells us two things. First, if you buy one more of good x, you get Px/Py less of good y. Here, Px/Py is known as the rate of substitution. Secondly, if the price of x changes, then the rate of substitution changes. This causes demand curves to slope down. While it may make some sense to suppose that an individual has a limited income for the time being, the level of income is not fixed over time. The same person can gain more productive skills or acquire more productive income-earning assets to earn a higher income. This part is the subject of theory of economic development. Again, something may happen to the economy beyond the control of the individual to reduce (or increase) the flow of income. This would be studied by theory of business cycle.

Distribution of Income

The distribution of income within a society can be measured by the Lorenz curve and the Gini coefficient.

This may reveal the existence of politically unacceptable inequality of income. There may be strong political pressure to adopt policies of income redistribution by taxing the richer people at a higher rate than the middle class and giving subsidies or income-support to the very poor in a variety of ways. Political economy tends to be highly controversial because people have conflicting opinion regarding income redistribution.

National income, measured by statistics such as the Net National Income (NNI), measures the total income of all individuals in the economy. For more information see measures of national income and output.

Optimal gini-coefficient

In their study for the World Institute for Development Economics Research, Giovanni Andrea Cornia and Julius Court (2001) reach policy conclusions as to the optimal distribution of wealth. The authors recommend to pursue moderation also as to the distribution of wealth and particularly to avoid the extremes. Both very high egalitarianism and very high inequality cause slow growth. Extreme egalitarianism leads to incentive-traps, free-riding, high operation costs and corruption in the redistribution system, all reducing a country's growth potential.

However also extreme inequality diminishes growth potential through the erosion of social cohesion, increasing social unrest and social conflict causing uncertainty of property rights. Therefore public policy should target an 'efficient inequality range'. The authors claim that such efficiency range roughly lies between the values of the Gini coefficients of 25 (the inequality value of a typical Northern European country) and 40 (that of countries such as China and the USA). The precise shape of the inequality-growth relationship depicted in the Chart obviously varies across countries depending upon their resource endowment, history, remaining levels of absolute poverty and available stock of social programs, as well as on the distribution of physical and human capital.

see: The Path to sustainable Growth - Lessons from 20 Years Growth Differentials in Europe

Income in Philosophy and Ethics

Throughout history, many scholars have written about the impact of income growth on morality and society. In particular, a number of scholars have come to the conclusion that material progress and prosperity, as manifested in continuous income growth at both individual and national level, provide the indispensable foundation for sustaining any kind of morality. This argument was explicitly given by Adam Smith in his Theory of Moral Sentiments, and has more recently been developed in depth by Harvard economists Benjamin Friedman in his well-acclaimed recent book The Moral Consequences of Economic Growth.

External links

Categories: