Economics · Ch 2 — National Income Accounting
Factor Cost, Basic Prices and Market Prices
Factor Cost, Basic Prices and Market Prices
The Shift from GDP at Factor Cost to GVA at Basic Prices
For many years, the most widely reported measure of national income in India was GDP at factor cost. The Central Statistics Office (CSO) used to release this as the headline figure. However, in January 2015, the CSO made a significant revision. It replaced GDP at factor cost with Gross Value Added (GVA) at basic prices as the primary production-side measure. The headline measure of the overall economy is now GDP at market prices (often simply called GDP).
This change was not just cosmetic. It reflects a clearer way of thinking about how taxes and subsidies affect the value of output at different stages.
The Three Valuation Concepts
The distinction between factor cost, basic prices, and market prices hinges entirely on how we treat two categories of taxes and subsidies: production taxes/subsidies and product taxes/subsidies.
A tax is a compulsory payment to the government. A subsidy is a grant from the government that effectively lowers the cost or price of a good or service. When we talk about "net" taxes, we mean taxes minus subsidies.
1. Factor Cost
Factor cost is the value of output measured from the perspective of the factors of production (land, labour, capital, entrepreneurship). It includes only the payments made to these factors — wages, rent, interest, and profit. Crucially, it excludes all taxes and includes all subsidies.
Think of factor cost as the true cost of production from the producer's viewpoint, before any government intervention through taxes or subsidies.
2. Basic Prices
Basic prices are a middle ground. They include net production taxes (production taxes minus production subsidies) but exclude net product taxes (product taxes minus product subsidies).
- Production taxes and subsidies are paid or received in relation to the act of production itself. They are independent of the volume of output produced. Examples include land revenue, stamp duty, and registration fees. A factory pays land revenue whether it produces 100 units or 1,000 units.
- Product taxes and subsidies are paid or received per unit of the product. They vary directly with the quantity produced or sold. Examples include excise duty, service tax, and export/import duties. If a company sells 10,000 phones, it pays excise duty on each phone.
So, basic prices = factor cost + net production taxes.
3. Market Prices
Market prices are the prices actually paid by the final consumer. They include all net taxes — both production taxes and product taxes.
Market prices = basic prices + net product taxes.
Alternatively, market prices = factor cost + net production taxes + net product taxes.
A common mistake is to think that "market price" is simply "factor cost plus all indirect taxes." That is correct in spirit, but the precise breakdown is: factor cost → add net production taxes → get basic prices → add net product taxes → get market prices. The two categories of taxes are treated separately.
The New CSO Framework
Under the revised system, the CSO now releases GVA at basic prices as the key production-side aggregate. This means the reported GVA already includes net production taxes but excludes net product taxes.
To arrive at the headline GDP at market prices, we must add net product taxes to GVA at basic prices.
Where:
- Net production taxes = Production taxes – Production subsidies
- Net product taxes = Product taxes – Product subsidies
A Summary Table
| Valuation Concept | Includes | Excludes |
|---|---|---|
| Factor Cost | Payments to factors of production | All taxes (production & product); includes all subsidies |