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Market price and factor cost.


What Is Factor Cost?

-A number of inputs are required in the production process. These inputs are commonly known as factors of production and include things such as land, labour, capital, and entrepreneurship. Producers of goods and services incur a cost for using these factors of production. Factor cost refers to the cost of factors of production that is incurred by a firm when producing goods and services. Examples of such production costs include the cost of renting machines, purchasing machinery and land, paying salaries and wages, cost of obtaining capital, and the profit margins that are added by the entrepreneur (profits are the cost of entrepreneur).

-The factor cost and market price does not include the taxes that are paid to the government since taxes are not directly involved in the production process and, therefore, are not a part of the direct production cost. However, subsidies received are included in the factor cost as subsidies are direct inputs into the production.

What Is Market Price?

Once goods and services are produced, they are sold at a market price. The market price is the price that consumers will pay for the product when they purchase it from the sellers. Taxes charged by the government will be added onto the factor price while subsidies provided will be reduced from the factor price to arrive at the market price.

Taxes are added because taxes are the costs that increase the price, and subsidies are reduced because subsidies compensate the factor cost or reduce market price and the factor cost. For instance, money is required to run a business. Thus, money is a factor of production. The cost of money is interest. Interest here is a factor cost. If government gives subsidy on interest, then actual cost of money (interest cost) will reduce.

Relationship between GDP at Market Price and GDP at Factor Cost

GDP (MP) – Indirect Taxes + Subsidies = GDP (FC)

Note: In common parlance, when we use the term GDP, we refer to GDP at market prices.


Gross value added (GVA) is the measure of the value of goods and services produced in an area, industry, or sector of economy.

Relationship to GDP:

GVA is linked to GDP, as both are measures of output. The relationship is defined as follows:

GVA + Taxes on products – Subsidies on products = GDP

Why GVA Is Calculated?

  1. GVA and GDP give a picture of economic activity from producers’ (supply side) and consumers’ (demand side) perspective, respectively, because GVA is the net receipt of the producers and GDP is the expenditure incurred by the consumers.
  2. Both these measures need not match and there could be a sharp divergence due to net indirect taxes (NIT = indirect taxes — subsidies), which are counted in GDP calculations (GDP is the sum of GVA and NIT).
  3. GVA provides a better measure of economic activity because GDP can record a sharp increase just on account of increased tax collections due to better compliance/coverage and not necessarily due to increase in output.
  4. GVA is a better reflection of the productivity of the producers as it excludes the indirect taxes, which could distort the production process.
  5. A sector-wise breakdown provided by the GVA measure can better help policymakers to decide which sectors need incentives/stimulus or vice

Introduction of GVA at Basic Prices in India

In the revision of the National Accounts Statistics in January 2015 by the CSO, it was decided that sector-wise estimates of GVA will now be given at basic prices along with the factor cost and market price

The basic price for any commodity is the amount receivable by the producer from the purchaser minus any tax on the product plus any subsidy on the product. However, GVA at basic prices will include production taxes and exclude production subsidies available on the commodity.

On the other hand, GVA at factor cost includes no taxes and excludes no subsidies and GDP at market prices and factor cost includes both production and product taxes and excludes both production and product subsidies.

The relationship between GVA at factor cost, GVA at basic prices, and GDP at market prices is as follows:

GVA at factor cost + (Production taxes less production subsidies) = GVA at basic prices

GDP at market prices = GVA at basic prices + Product taxes — Product subsidies

What Are Production Taxes and Subsidies?

Production taxes or production subsidies are paid or received with relation to production and are independent of the volume of actual production. Production taxes or production subsidies are given even if the products are not produced.

Some examples of production taxes are land revenue, registration fees, property taxes, and tax on profession. Some production subsidies include subsidies on tractors, on interest for loan, to village and small industries.

What Are Product Taxes and Subsidies?

Product taxes or subsidies are paid or received on per unit of product. Some examples of product taxes are excise tax, sales tax, service tax, and import and export duties. Product subsidies include food, petroleum, and fertilizer subsidies.

GVA at Basic Price versus Factor Cost

The difference between the value of the intermediate inputs and the value of the outputs is GVA.

Two kinds of prices to measure output, namely basic prices and factor cost, are:

  • The basic price is the amount receivable by the producer from the purchaser for a product or service minus any tax payable and plus any subsidy receivable by the producer as a consequence of its production or sale.
  • The GVA at factor cost is the amount receivable by the producer from the purchaser for sale of goods or services produced minus any production as well as product taxes paid by the producer and plus any production or product subsidies received by the producer.

The basic price measures the amount retained by the producer and is, therefore, the relevant price for the producer’s decision-taking.

GVA at factor cost is essentially a measure of income and not output. It represents the amount remaining for distribution out of GVA after the payment of all taxes and receipt of all subsidies.

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