Briefly explain the following basic concepts related to NI:
Factor Cost vs. Market Price (or Net Indirect Taxes)
Money value of final goods and services produced can be estimated in two ways — at factor cost (FC) and at market price (MP). Simply put, difference between FC and MP is 'net indirect tax'. Net indirect tax is the difference between indirect tax and subsidy.
(i) Factor cost refers to all factor payments made by the producing unit (firm) to the factors of production involved in the production of goods and services. It is called factor cost because it is cost incurred by the producer (firm) who pays to factors in the form of rent, wages, interest and profit. (i.e., rent for land, wages for labour, interest for borrowed money (capital) and profit for undertaking risks involved in production — a reward for entrepreneur). If sum of factor payments in production of a commodity is, say र 1 lakh, then value of the product at factor cost is र 1 lakh.
(ii) Market price is the price at which a commodity is sold and purchased in the market. The point to be noted is that when a product goes to the market for sale, government levies indirect tax (like sale tax, excise duty, etc.) which is added to the factor cost of the commodity. Similarly sometimes government gives subsidy on sale of certain commodities (like kerosene oil, sugar, rice at ration shops) which is subtracted from factor cost. As a result market price becomes higher than factor cost in case of levy of indirect tax and lower than factor cost in case of grant of subsidy. In short MP includes Net indirect taxes (Indirect taxes - Subsidies) whereas FC does not. Put in the form of an equation:
Market price = Factor cost + Indirect taxes - Subsidies = Factor cost + Net indirect taxes
Net indirect tax is the difference between indirect taxes and subsidies as explained below. Let us be clear about the concepts of indirect taxes and subsidies.
(a) Indirect taxes. Taxes which are levied by the government on production and sale of commodities are called indirect taxes, e.g., excise duty, sale tax, custom duty, octroi, etc. The buyer of a taxed commodity pays the tax indirectly because the tax is included in the price which the buyer pays. What is the effect of indirect tax on the price of a commodity on which it is levied? The impact of indirect tax is that it increases the price of a commodity.
(b) Subsidies. These are cash grants given by the government to the enterprises to encourage production of certain commodities or to promote exports or to sell goods at prices lower than the free market prices. Subsidies are opposite of indirect taxes.
What is the impact of a subsidy on the price of a commodity on which it is granted? The effect of subsidy is fall in the price of a commodity. For example, Delhi Milk Scheme sells 1 litre poly bag of toned milk for र 20.00 whereas the same costs it र 21.00. The difference or loss of र 1.00 is made good by the Government by giving subsidy of Re. 1.00 per litre of toned milk. Thus the market price of a subsidised commodity is lower than its factor cost.
