What Is Per Capita Income? Formula, Examples, and Limitations

You'll often spot the term ‘per capita income’ in newspaper business sections and economic reports. While many learn about it in school, its real-world impact goes beyond the classroom. Per capita income helps us understand economic health and living standards. It's also a valuable tool for comparing wealth between different regions or countries. This article explores its meaning, how it is calculated, and a few of its limitations.

Meaning of Per Capita Income

Per capita is a measurement that represents averages per person. It is commonly used in economics and statistics to compare different populations. Per capita income shows how much money each person in an area earns on average. This measurement serves multiple purposes:

• It indicates the general standard of living in an area.

• It helps businesses make location-based decisions.

• It helps assess housing affordability.

• It enables fair comparisons between countries of different sizes.

How To Calculate Per Capita Income?

Per capita income is calculated by dividing total national income by the entire population. The total income includes all forms of revenue like salaries, wages, profits, remittances, and overseas investments.

The population count includes every resident, regardless of their citizenship or legal status, who has lived in the country for any specified period. This metric is typically calculated annually and expressed in a specific currency like the rupee.

Formula For Per Capita Income

Per capita income is calculated using a straightforward formula:

Per capita income = Total income of the area / Total population

Total income of the area is the sum total of all the earnings within an area during a specified timeframe. This includes employment wages, business profits, and other income sources. The population figure accounts for all residents within the designated area, regardless of their age, employment status, or economic contribution.

Uses Of Per Capita Income

Economic Health Indicator: Per capita income also provides insights into country's economic health check. When it's high, it usually means people have enough money to live comfortably. They have access to superior healthcare, quality education, and good housing. When it's low, many people might struggle to meet their basic needs.

Policy Making: Government officials use per capita income numbers to make policy decisions. For example, if one region of the country has very low per capita income, they might create special programs to bring more jobs to that area. They might also offer training programs or build better infrastructure to boost economic growth where it is needed the most.

Business Decision-Making: Businesses also find per capita income very useful for making business choices. Before opening a new store or launching a product, they look at the per capita income of an area. This helps them understand if people there can afford their products. For instance, a luxury car dealer would probably choose to open a showroom in an area with high per capita income.

Research and Analysis: Per Capita Income helps economists/ other experts in researching the effect of income on other variables like heath, education, or environmental factors.

Limitations Of Per Capita Income

Quality Of Life Measurement Problem: Per capita income takes all the money earned in an area and divides it by the number of people living there. This oversimplified per capita income calculation doesn't tell us about income distribution or inequality within a population. 

Inflation Blind Spot: Per capita income doesn't account for inflation. If your income goes up by 10% but prices also go up by 3%, so your actual purchasing power increases by only 7%. Per capita income numbers don't show this important difference.

Different Living Costs: Comparing per capita income between countries can be misleading because living costs vary greatly. For instance, $500 might let you live comfortably in a small town in India but barely cover basic expenses in New York City. The formula doesn't consider these important differences in living costs or currency values.

Hidden Wealth: Per capita income only looks at yearly earnings, not at savings or inherited wealth. A retired person might have a very comfortable life but show zero income. Or consider a wealthy person who doesn't work - they might look poor in per capita income statistics despite living luxuriously.

Child Population Impact: The formula gets skewed in countries with many children. Since children typically don't earn income but are counted in the total population, they lower the per capita income number. This makes countries with younger populations appear poorer than they actually are.

Per Capita Income Example

Imagine 10 people working in a big international company. Their monthly salaries vary: two people earn ₹1 lakh each, two earn ₹ 1.2 lakh each, two earn ₹ 2 lakh each, one person earns ₹ 80,000, one earns ₹ 1.8 lakh, and two earn ₹1.5 lakh each.

When we add all salaries and divide by 10 people, the per capita income is ₹ 1.4 lakh.

Now, let's assume, we now have 14 people, but only 10 are employed. The other 4 people have no income. When we calculate the new per capita income by dividing the total income by 14 people, it drops to ₹ 1 lakh.

This shows why per capita income calculations must include the entire population to give an accurate picture of a country's economic status.