Factor cost

Topic: National Income Accounting: GDP, GVA and Welfare · NCERT: Class 12, Ch 2 "National Income Accounting"

Meaning

Factor cost is the value of output counted only as the income paid to the factors of production: wages to labour, rent to land, interest to capital and profit to the entrepreneur. It is the amount the producer actually receives. No indirect tax is added, and no subsidy is taken away.

Formula: Factor cost = Market price − Net indirect taxes, where Net indirect taxes = Indirect taxes − Subsidies.

It matters because it shows the true reward of the people and resources that produced the output, without any effect from government taxes or subsidies. Until the January 2015 revision, India's headline growth number was measured at factor cost.

Explanation

How it works

• One unit of output can have three different values. The value depends on which taxes and subsidies you count.
• Indirect taxes are taxes on goods, services or production, not on income. They make the buyer pay more than the producer receives.
• Subsidies are payments from the government. They make the buyer pay less than the producer receives.
• Factor cost sits at the bottom of this chain. It is the producer's side of the price, and all taxes and subsidies are removed from it.
• Everyday examples:
• Petrol is heavily taxed, so its market price is well above its factor cost.
• Cooking gas (LPG) is subsidised, so its market price is below its factor cost.

The two taxes you must remove

• Production taxes are paid simply because a firm produces at all. They do not depend on how much it produces.
• Examples: land revenue and stamp and registration fees [5].

• Net production taxes = production taxes − production subsidies.

• Product taxes are charged per unit of a good or service that is produced or traded.

• Examples: GST, excise duties and customs duties.
• Examples of product subsidies: food, petroleum and fertiliser subsidies [5].

• Net product taxes = product taxes − product subsidies.

• Service tax: NCERT still lists it as a product tax. It was subsumed into GST from July 2017.

• To reach factor cost, you must remove both kinds of net taxes. If you remove only one, you land at a different price base.

The valuation chain, with a worked example

• GVA at factor cost + net production taxes = GVA at basic prices
• GVA at basic prices + net product taxes = GDP at market prices
• GDP at factor cost = GDP at market prices − net product taxes − net production taxes

Worked example (₹ crore, one small economy):

Step	Item	Value
1	GVA at factor cost (wages + rent + interest + profit)	100
2	+ Production taxes 6 − production subsidies 1	+5
3	= GVA at basic prices	105
4	+ Product taxes (GST, excise) 18 − product subsidies (fertiliser) 3	+15
5	= GDP at market prices	120
6	GDP at factor cost = 120 − 15 − 5	100

• The trap: 120 − 15 = 105. That is GVA at basic prices, not factor cost. You must also subtract the 5 of net production taxes.

What makes the gap between factor cost and market price grow or shrink

• The gap widens when indirect taxes rise or subsidies are cut.

• Taxes go up → buyers pay more → market price moves further above factor cost.

• The gap narrows, or even turns negative, when subsidies rise.

• Subsidies go up → buyers pay less → market price moves closer to factor cost, or falls below it (as with LPG).

• In all these cases, factor cost itself does not change. Only the tax and subsidy layer on top of it changes.

In India

• Who measures it: the Central Statistics Office (CSO), which is now part of the National Statistical Office (NSO) under MoSPI (Ministry of Statistics and Programme Implementation).
• The January 2015 revision (base year 2004-05 → 2011-12):
• The headline measure changed from GDP at factor cost to GDP at market prices, now simply called "GDP".
• Sector-wise estimates moved from factor cost to GVA at basic prices.
• The series followed the UN System of National Accounts 2008 (SNA 2008), the international rulebook for national accounts. NCERT Class 10 calls this being "at par with global practices".

• The MCA-21 database of company filings (Ministry of Corporate Affairs) was used for the private corporate sector.

• Official formula today: "GDP (Production/Income Approach) = GVA at Basic Price + Net Taxes on Products" [4]. Factor cost is no longer published as the headline figure.

• Current series (base year 2022-23, released 27 February 2026):
• It replaces the 2011-12 series and still follows SNA 2008 [2][3].
• The valuation framework is unchanged: GDP = GVA at basic prices + net taxes on products [2][3].
• 2025-26 (Second Advance Estimates, current prices): GVA at basic prices ₹3,13,60,846 crore + net taxes on products ₹31,86,311 crore = GDP ₹3,45,47,157 crore [3].

• Net product taxes were about 9.2% of GDP in 2025-26 [3].

• How MoSPI measures the tax layer (2024-25 estimates):

• Taxes on products come from CGA (Controller General of Accounts) and CAG data. They cover both GST and non-GST revenue [4].

• The Centre's product subsidies are built from the food, urea, petroleum and nutrient-based subsidies [4].

• NCERT error to watch (Class 12, Table 2.4): NCERT defines GDP at factor cost as "GDP_MP less net product taxes". That formula actually gives GVA at basic prices. Net production taxes must also be deducted.

Don't confuse with

• Basic prices: these equal factor cost plus net production taxes (land revenue, stamp duty). Factor cost has no taxes at all.
• Market prices: this is what the buyer pays. It equals factor cost + all net indirect taxes (both production and product taxes).
• GDP at market prices − net product taxes: this gives GVA at basic prices, not GDP at factor cost. It is the most common exam trap, and NCERT itself makes this mistake.
• Direct taxes (like income tax): these are paid out of factor incomes. They are not removed when moving from market price to factor cost. Only indirect taxes are removed.

Prelims Hooks

• Factor cost = Market price − Indirect taxes + Subsidies, i.e. Market price − Net indirect taxes.
• GVA at factor cost + net production taxes = GVA at basic prices. GVA at basic prices + net product taxes = GDP at market prices.
• Land revenue and stamp and registration fees are production taxes. GST, excise and customs are product taxes [5].
• Market price > factor cost when net indirect taxes are positive (petrol). Market price < factor cost when subsidies exceed taxes (LPG).
• January 2015 revision: the headline moved from GDP at factor cost to GDP at market prices, and sectoral data moved to GVA at basic prices, under SNA 2008.
• Trap: "GDP at market prices minus net product taxes equals GDP at factor cost". This is wrong. The result is GVA at basic prices.

Mains Points

• Why India moved away from factor cost as the headline:
• Factor cost removes every tax, so it shows pure producer income. But it does not match what buyers pay or how other countries report.
• The 2015 shift to market prices and basic prices under SNA 2008 made India's data comparable across countries [2].

• The trade-off is that factor-cost numbers are now less visible in public discussion, even though they measure the income of labour and capital most directly.

• Fiscal policy hides in the gap above factor cost:

• When subsidies rise (food or fertiliser in a shock year) or taxes fall, market-price GDP moves closer to factor cost.
• When GST collections rise or subsidies are rationalised, market-price GDP moves further above factor cost.

• So headline GDP growth can partly reflect tax and subsidy choices, not only real production. Factor-cost or basic-price measures give a cleaner view of what was actually produced.

• Analysing welfare and income distribution:

• Factor cost adds up wages, rent, interest and profit, so it is the natural base for studying who earns national income, for example the labour share compared with the capital share.
• Market-price figures mix these incomes with government revenue, which can blur such analysis.

Related concepts

• Basic prices
• Market prices
• Production taxes
• Product taxes
• Net indirect taxes
• GDP at factor cost
• GVA at factor cost
• GVA at market prices

Read more

• Valuation: factor cost, basic prices and market prices (the 2015 revision)