Learn the Basic Commerce Terms
Market Price, Factor Cost, and Basic Price are the basic concepts that are to be learned and understood by the students at their basic level. This content is especially to make the foundation strong. Factor cost, basic prices, and market prices are amongst some of the most essential curricula for students who have selected the Commerce stream as their 10+2. To understand these in a better way, it is essential to get to know the basics of the terms.
Definitions of the Terms – Factor Cost, Basic Price, and Market Price
Factor Cost
The total cost incurred in deploying all factors, that led to the production or generation of goods and commodities available in the market, is known as factor cost.
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. Therefore, the formula for the Basic price can be written as
Basic price = factor cost + Production taxes – Production subsidy
Where production tax and production subsidy are determined in reference to production and don’t necessarily depend upon the volume of actual production. Therefore, stamp duty, registration fee, land revenues, etc. are a few examples of production tax. And these production subsidies are given to farmers, small industries, administrative subsidies to cooperatives, etc.
This is how one can calculate the basic price of a commodity receivable by the producer of the good.
Market Price
As the name suggests, the market price is a measure of the amount at which goods or commodities are made available to the general consumer for sale. 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.
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.
Subsequently, one can calculate the market price of a commodity with this formula mentioned below –
Market Price = P + T – S
Where,
P = Basic price
T = Product taxes
S = Product subsidy
Where product tax and product subsidy are determined in reference to production and don’t necessarily depend upon the volume of actual production.
What is GDP at Factor Cost?
To understand this concept of GDP at factor cost, you first need to understand a few pointers as mentioned below.
GDP and GVA are the tools that are used for measuring the economic growth of a nation.
GDP stands for Gross Domestic Product and is the measure of the value of the end-products produced in a country.
GVA stands for Gross Value Added, and it quantifies the value of the total production of goods and commodities in a nation.
Therefore, GDP at Factor cost is the total value of goods and commodities produced in a year in a country by its all-production units. This value calculated here is inclusive of depreciation as well.
GDP at Factor Cost = Sum of all GVA at factor cost.
GDP at Market Price = GDP at factor cost + Product taxes + Production tax – Product subsidies – Production subsidies.
Test Your Knowledge
Q1. GDP is a Measure of
A country’s income
Consumer spending
A country’s wealth
Net trade income
Q2. Adjusting GDP from Market Prices to Factor cost Requires
Addition of indirect taxes
Subtraction of subsidies
Deduction of indirect taxes and subsidies
Deduction of indirect taxes and addition of subsidies
Q3. A Higher GDP Per Capita Does not Mean that Quality of life has Improved in the Area, and the Reasons are
It does not measure the quality of items produced in the country
It is only measured every 5 years
It measures wealth and not income
It measures gross domestic product
Q4. The Value of Domestic Output Attained by Residents of Country before Depreciation and Addition of Influence of Taxes and Subsidy is known as
GDP at factor cost
GNP at factor cost
GNP at market prices
GDP at market prices
NNP at factor cost
With this concept of such costs and prices in place, students will be able to learn the nuances of this subject better. They can further acquire help and in-depth knowledge of the topic by going through Vedantu’s website. We offer detailed learning exposure to students willing to reach the extra mile in their academics.
FAQs on Market Price vs. Factor Cost vs. Basic Price
1. What is the fundamental difference between Factor Cost, Basic Price, and Market Price?
The fundamental difference lies in the treatment of government taxes and subsidies. Factor Cost (FC) is the producer's cost before any taxes are added or subsidies are deducted. Basic Price (BP) is the Factor Cost plus production taxes (like registration fees) minus production subsidies. Finally, Market Price (MP) is the price paid by the consumer, which is the Basic Price plus all product taxes (like GST) minus all product subsidies.
2. How are Market Price (MP) and Factor Cost (FC) calculated in Class 12 Economics?
The conversion between these two key macroeconomic aggregates depends on Net Indirect Taxes (NIT). The standard formulas are:
- Market Price (MP) = Factor Cost (FC) + Net Indirect Taxes (NIT)
- Factor Cost (FC) = Market Price (MP) – Net Indirect Taxes (NIT)
Here, Net Indirect Taxes (NIT) is the difference between all Indirect Taxes (e.g., GST) and all Subsidies provided by the government on a product.
3. Can you explain the difference between Market Price and Factor Cost with a numerical example?
Certainly. Imagine a factory produces a book with the following costs:
- The total cost of all factors of production (wages, rent, profit, etc.) is ₹200. This is the Factor Cost (FC).
- The government imposes a Goods and Services Tax (GST) of ₹10 on the sale of each book.
- The government also provides a subsidy of ₹5 to the producer to encourage educational materials.
First, we calculate Net Indirect Taxes (NIT) = Indirect Tax - Subsidy = ₹10 - ₹5 = ₹5. Then, the Market Price (MP) = Factor Cost (FC) + NIT = ₹200 + ₹5 = ₹205. This is the final price the consumer pays.
4. What is the role of 'Net Indirect Taxes' in converting Factor Cost to Market Price?
Net Indirect Taxes (NIT) acts as the crucial bridge between the price earned by a producer (Factor Cost) and the price paid by a consumer (Market Price). It represents the net financial impact of government intervention on a product's final price. A positive NIT means taxes are higher than subsidies, making the MP greater than the FC. A negative NIT means subsidies outweigh taxes, making the MP lower than the FC.
5. Why do economists use three different price concepts (MP, FC, and BP) to measure national income?
Economists use these different concepts to analyse the economy from distinct viewpoints:
- Factor Cost (FC) helps analyse the income distributed to the factors of production (wages, rent, interest, profit). It reflects the earnings side of the economy.
- Basic Price (BP) provides a measure of the revenue a producer receives, which is useful for analysing sector-specific output and profitability before market-level taxes are applied.
- Market Price (MP) is used to measure the total expenditure in an economy, reflecting the market value of all final goods and services as paid by consumers.
Using all three is essential for the three different methods of calculating GDP (Income, Production, and Expenditure methods).
6. How do government policies, like changes in GST rates or subsidies, affect the Market Price?
Government policies directly influence the Market Price by altering the Net Indirect Taxes (NIT).
- Increase in GST/Indirect Taxes: If the government raises the GST rate on cars, the NIT component increases. This leads to a higher Market Price for consumers, even if the manufacturer's Factor Cost hasn't changed.
- Increase in Subsidies: If the government increases the subsidy on LPG cylinders, the NIT component decreases. This reduces the Market Price consumers pay, making the product more affordable.
7. Is Factor Cost the same as the cost of raw materials for a producer?
No, this is a common misconception. The cost of raw materials is an intermediate cost. Factor Cost is a much broader concept that represents the sum of payments made to all four factors of production for their contribution. These include:
- Rent for Land
- Wages and salaries for Labour
- Interest on Capital
- Profit for Entrepreneurship
Therefore, Factor Cost reflects the total income earned by these factors, not just the material input cost.
8. In the context of national income accounting, what is the difference between 'production taxes' and 'product taxes'?
This distinction is crucial for understanding the difference between Factor Cost, Basic Price, and Market Price.
- Production Taxes are levied on a business for the act of producing, regardless of the volume. Examples include land revenues, stamp duties, and professional taxes. These are added to Factor Cost to get Basic Price.
- Product Taxes are levied per unit of the good or service produced or sold. The most common example is GST. These are added to Basic Price to arrive at the final Market Price.
Similarly, production subsidies are independent of volume, while product subsidies are given on a per-unit basis.
