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How Discretionary Income Works

        Money | Taxes

Discretionary Income and the Middle Class

For economists, discretionary income and spending are important markers for assessing the overall health of an economy. Gross Domestic Product is one of the leading indicators that investors and economic observers look at to get a snapshot of a country's economic state. GDP is, in effect, a country's national income. It's also used to measure a government's financial stability by comparing the government's debt to the country's overall GDP [source: Thorne].

When they want to look at a particular segment of society, however, economists drill down from a national viewpoint by using data like discretionary income. The middle class has been defined as individuals and households who have a "reasonable amount of discretionary income." What's reasonable, of course, depends largely on whether you live in an impoverished, developing or established country. The main point is that folks in the middle class have enough discretionary money that they don't have to live paycheck to paycheck. They also have some money to spend on non-essentials [source: Parker].

Some theorists argue that middle-class growth — which happens when more people have enough discretionary income to enter the middle class — is a good indicator of overall economic progress. The more money that people have to spend on discretionary goods and services, the more likely they are to spend it, the thinking goes. That, in turn, puts money into other people's pockets and stimulates the economy as a whole.

A strong middle class can also help grow a nation's economy by stimulating investment and business activity. The idea is that more business owners will hang out more "Open" signs when the pot of spending money for which they're competing is larger than when the pot is smaller. In other words, a strong middle class offers stable consumer demand.