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Factor Cost, Basic Prices and Market Prices | UPSC Economy Notes

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Factor Cost, Basic Prices and Market Prices

Factor Cost

  • Factor cost refers to the cost of production in terms of payments made to factors of production.
  • It includes factor payments such as:
    • Wages to labour
    • Rent to land
    • Interest to capital
    • Profit to entrepreneur
  • Factor cost does not include any taxes. It only represents the income earned by factors of production.
  • In simple words:
    • Factor Cost = Income received by factors of production

Market Price

  • Market price means the price paid by the final buyer in the market.It includes the price received by producers plus indirect taxes, and excludes subsidies.
  • Market Price = Factor Cost + Indirect Taxes – Subsidies

Factor Cost vs Basic Prices vs Market Prices

  • The distinction between factor cost, basic prices and market prices is based on the distinction between net production taxes (production taxes less production subsidies) and net product taxes (product taxes less product subsidies). 
    • Production taxes and subsidies are paid or received in relation to production and are independent of the volume of production such as land revenues, stamp and registration fee. 
    • Product taxes and subsidies, on the other hand, are paid or received per unit or product, e.g., excise tax, service tax, export and import duties etc. 
  • Factor cost includes only the payment to factors of production, it does not include any tax. 
  • In order to arrive at the market prices, we have to add to the factor cost the total indirect taxes less total subsidies. 
  • The basic prices lie in between: they include the production taxes (less production subsidies) but not product taxes (less product subsidies). Therefore in order to arrive at market prices we have to add product taxes (less product subsidies) to the basic prices.

Basic Price

  • Basic Price lies between factor cost and market price.
    • Basic price includes:
      • Factor cost
      • Net production taxes
    • But it does not include net product taxes.
    • Therefore, Basic Price = Factor Cost + Net Production Taxes
      • Where, Net Production Taxes = Production Taxes – Production Subsidies
  • Gross Value Addition (GVA) at factor costs + Net production taxes = GVA at basic prices
  • GVA at basic prices + Net product taxes = GVA at market prices 
  • GVA basic prices + product taxes – Product subsidies = GDP at market prices 
  • Since production taxes minus production subsidies are generally very small compared to other components, they can be ignored for practical understanding.
  • Therefore, for simplicity, we can say:
    • GVA at Basic Prices ≈ GVA at Factor Cost
  • This means that, in practical terms, GVA at basic prices and GVA at factor cost may be treated as nearly the same, though conceptually they are different.

*In India (since January 2015 onwards) we calculate GDP at Market Prices rather than at Factor Cost. 

Factor cost, basic prices and market prices represent different ways of valuing output in national income accounting. Factor cost focuses on income received by factors of production, basic price adds net production taxes, and market price reflects the price paid by the final buyer after adding indirect taxes and deducting subsidies.

FAQs

What is factor cost?

Factor cost refers to the cost of production in terms of payments made to factors of production such as wages, rent, interest and profit.

What is market price?

Market price is the price paid by the final buyer in the market. It includes indirect taxes and excludes subsidies.

What is basic price?

Basic price lies between factor cost and market price. It includes factor cost plus net production taxes, but excludes net product taxes.

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