Factor Cost

Factor cost is a concept which focuses on the cost incurred on the factor of production. The total cost of goods and services that is produced by industries and firms is the factor cost. The factor cost includes all the costs such as land, labour, raw materials, and transportation. The relationship between the cost of production and level of investment is defined in microeconomics and macroeconomics respectively. 

 

What is the meaning of Factor Cost?

The factor cost is the cost that excludes all the taxes and subsidies. It is the price that is incurred in the production of goods or services like labor, capital, land, etc. The factor cost is often used to analyze the economic perspective and the national accounts for understanding the costs that incurred while producing the product. When comparing with basic price, they both exclude taxes. For example when a manufacturer spends INR 30,000 on labor, raw materials, and capital to produce a washing machine, the factor cost of the washing machine is INR 30,000, excluding the indirect taxes.

There are governing features in the factor cost estimation: 

• No indirect taxes: The factor cost does not include taxes like the sales tax, VAT, subsidies

• Production costs: Shows the direct costs incurred by the production for factors like labor, capital, and raw materials.

• National accounts: The factor cost is an important part in the calculation of GDP using the income approach and evaluates the production efficiency.

 

Read more with Market Price vs Factor Cost vs Basic Price and dive deeper into the topic. 

 

Formula for Factor Cost Calculation

The factor cost is determined by subtracting the indirect taxes and adding any subsidies to the market price. It is the cost of production. 

 

Factor Cost = Market Price - Indirect taxes + Subsidies

 

What are the components of Factor Cost?

There are four main components of the factor cost that contribute to its workings. These are the inputs that go into the production of goods or services. They are essential for the calculation of economic value. 

The components of factor cost are tabulated below:

 

Factor of production	Type	Description
Land	Rent	Paid for the usage of natural resources
Labour	Wages	Compensation paid to the employees
Capital	Interest	The return on investment capital or funds borrowed
Entrepreneurship	Profit	Earning after the business risks

 

What is the significance of Factor Cost?

The whole concept of factor cost was summarized by Crepon and Gianella. They integrated elements such as bank interest rates, balance sheet, taxation of the companies and shareholders. Depreciation had a major impact as an element in the factor cost determination. All of these elements indicate the effective cost of capital. 

Here’s the significance of the factor cost:

• The factor cost plays a crucial role in the determination of the national income. 
• In macroeconomics the countries use GDP at factor cost to determine the health of economy
• The whole tax distortion is excluded while measuring and comparing the productivity
• Helps the policymakers to understand the income distribution 
• The businesses are able to determine the cost per unit of output
• It important for measuring internal pricing and budgeting 
• Estimates the effect of indirect taxes and subsidies 
• Reflects whether a particular sector is productive or tax-inflated

 

Read More 

• Consumer Equilibrium Utility Analysis 
• Tender 
• Equity 
• Public Distribution System

 

Discover what you didn’t know you needed to know. Read Commerce Concepts for 11th and 12th!

 

Frequently Asked Questions (FAQs)

How is the factor price different from market price?

The factor cost is the cost that excludes all the taxes and subsidies. It is the price that is incurred in the production of goods or services like labor, capital, land, etc. Whereas the market price is the actual price at which the goods and services are actually bought and sold in the market. 

What is the effect of factor cost on national income calculations?

The national income is mostly calculated at factor cost as it measures the economy earned from production. 

Is factor cost higher than market price?

Yes, sometimes the factor cost is higher than market price, if the subsidies are high and the indirect taxes are low. However mostly the market price is higher than the factor cost due to the indirect taxes.