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Equivalisation

What is Equivalisation?

Equivalisation is a standard methodology in economics in which the household income is modified to account for the different financial needs of different household sizes and composition. The incomes of different household types are made comparable by accounting for shared consumption benefits.

 

Equivalisation
Fig. 1. UK Equivalised Income Distribution. Source: D Wells [CC BY-SA]

Considering the household size is important because the larger the household, the more the income that will be needed to keep the same standard of living. Financial resource requirements are also affected by the composition of a household. For example, adults will require higher living costs than children.

 

 

Quick Summary

  • Equivalisation is a term that describes the measurement of household income by giving the members of a household different weightings.
  • Equivalised income is calculated by dividing the total household income by the total of the weightings.
  • The most commonly used equivalence scales include the OECD equivalence scale, the OECD-modified equivalence scale, and the square root equivalence scale.

 

Equivalised Income

Equivalised income is the total household income that’s been recalculated to take into consideration differences in household demographic composition and size. If households show identical equivalised incomes, their standard of living can be said to be equal.

Here is how equivalised income is calculated:

  1. All disposable incomes from every household member are first added up. The sum excludes the paid taxes and social contributions. The reference period for the income is typically a year.
  2. To reflect differences in a household’s composition and size, a standard scale is used to give the members of a household different weightings depending on their age. The weightings are then added up to get an “equivalent size.”
  3. The total income of the household is then divided by the total of the weightings to give a representative income. The equivalised income figure is attributed equally to each household member.

 

Equivalence Scales

An equivalence scale refers to a measure of the cost of living of a particular household size and composition, compared with the cost of living of a reference household when both households achieve the same standard of living. The reference household is usually a single adult. Household needs usually increase with each extra member. However, the growth does not usually happen in a proportional way because of economies of scale in consumption.

For example, the needs of a household with four members won’t be four times higher than for a single person. Equivalence scales help to assign each household type a value according to its needs. Household size and the age of its members are the factors that are commonly put into consideration in assigning the values. All household members are given a weight, which is added up to get the equivalised household size.

Here are some of the most common equivalence scales used in equivalisation:

 

1. OECD equivalence scale

The OECD equivalence scale was mentioned by the OECD in 1982 for potential use in countries with no established equivalence scale. It is for this reason that the scale is sometimes called the “old OECD scale.” The OECD equivalence scale assigns values as follows:

  • Value of 1.0 to the first household member aged 14 years and over;
  • Value of 0.7 to each additional household member aged 14 years and over; and
  • Value of 0.5 to each child who is under 14 years old.

 

2. OECD-modified equivalence scale

The OECD-modified equivalence scale was adopted by Eurostat in the late 1990s. Eurostat is currently using it. The scale assigns values as follows:

  • Value of 1.0 to the first household member aged 14 years and over;
  • Value of 0.5 to each additional household member aged 14 years and over; and
  • Value of 0.3 to each child who is under 14 years old.

 

3. Square root equivalence scale

The square root equivalence scale can be found by recent OECD publications. The total household income is divided by the square root of the sum of the weightings.

 

Additional Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Demographics
  • Gross Income
  • Head of Household
  • Normal Goods

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