Economy Simplified: Learn about these terms-Factor Cost, Basic Price and Market Price and their interrelationship.

Factor Cost:

1. Factor Cost is the cost of the factors of production (that is, labour, capital, land and enterprise).
2. It is a measure on the cost of factors of production, instead of market prices. 
3. This allows the effect of any subsidy or indirect tax to be removed from the final measure.
4. In other words, Factor Cost is before we have deducted the subsidy the government has paid to support products and production, and before we have added the taxes on products and production, such as VAT paid to the government.

Basic Price:

It is the value or amount which a producer expects to receive from the consumer by selling one unit of product. This amount receivable is exclusive of all taxes and inclusive of subsidy.
Basic price = factor cost + Production taxes – Production subsidy

Market price:

1. The market price is a measure of the amount at which goods or commodities are made available to the general consumer for sale.
2. This total cost is inclusive of the entire production cost right from the purchase of raw material to worker wages, input prices, rent, interest, profit, etc.
3. Unlike basic Price, it is inclusive of the imposed taxes on the goods to be sold in the market. It also deducts the subsidies offered by the government if there are any.
Market Price = Basic Price + Production Taxes – Production Subsidy

The interrelationship between Factor Cost, Basic Prices and 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.

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