Cost and Price of National Income
When we calculate a country's
national income (total value of goods and services), we need to consider two
things: Cost and Price. There are two ways to measure each:
(i) Cost: Factor Cost vs.
Market Cost
- Factor Cost (Factory Price/Production
Cost):
- This is the producer's cost to
make something.
- It includes all the input costs
needed for production:
- Capital cost (interest on loans)
- Raw materials
- Labor wages
- Rent for land/buildings
- Power/electricity costs
- ...and other production expenses.
- Think of it as the "price" from
the factory gate.
- Market Cost (Market Price/Ex-factory
Price):
- This is the price when goods reach
the market or showrooms.
- It's calculated by taking the Factor
Cost and adding indirect taxes.
- In India, these indirect taxes were
mainly central excise duty (cenvat) and Central Sales Tax
(CST) paid to the central government. (Note: GST is now relevant).
- State taxes
are added later to get the final price you see in shops.
- Think of it as the "price" leaving
the factory, including central taxes.
- India's Choice: Factor Cost
- India and most developing countries
often calculate national income at Factor Cost.
- Reasons:
- Tax Uniformity Issues:
Taxes used to be different across states and not very uniform, making
Market Cost calculations complex and less consistent.
- Price Tagging:
Goods in India often didn't have printed prices showing all taxes
clearly.
- GST Impact:
The Goods and Services Tax (GST) is bringing more tax uniformity
to India, especially for central taxes. State taxes are still less
uniform. GST may eventually make Market Cost more practical.
- Statistical Data:
Even though Factor Cost is preferred, India's Central Statistical
Organisation (CSO) also releases national income data at Market
Cost for statistical purposes.
(ii) Price: Constant Price
vs. Current Price
- Current Price (Nominal Price/Maximum
Retail Price - MRP):
- This is the price you see today,
in the current market.
- It includes the effect of present-day
inflation.
- Basically, it's the MRP printed
on products.
- Constant Price (Real Price):
- This price removes the effect of
inflation.
- Inflation is "frozen" at a base
year (a past year chosen as a reference).
- This allows us to see how much the actual
quantity of goods and services produced has grown, without price
changes due to inflation distorting the picture.
- Base Year in India:
India's base year was revised to 2004-05 (announced in September
2010), replacing the old 1993-94 base year. Data using the new base year
is called the "new series".
- India's Choice: Constant Price
- India and other developing economies
usually calculate national income at Constant Prices.
- Reasons:
- Inflation Challenge:
India has historically faced significant and fluctuating inflation.
- Poverty Measurement:
High inflation can make it seem like poor people's incomes are rising
(in current prices), even if they are not actually better off in real
terms (constant prices). Using constant prices helps to measure the real
impact of poverty programs.
- Statistical Data:
CSO also releases national income data at Current Prices for
statistical purposes, but Constant Price is preferred for policy and real
growth analysis.
- Developed Economies & Current Prices:
- Developed nations
often calculate national income at Current Prices.
- Reason:
They typically have low and stable inflation (e.g., around 2% for
decades).
- The difference between Constant Price
and Current Price income is small and predictable for them.
- Current price data is considered more reliable
and realistic in stable, low-inflation economies.
(iii) Forms of Income for a
Person:
- Nominal Income:
The actual wage or salary you receive in hand (e.g., rupees per
day/month).
- Real Income:
Your Nominal Income adjusted for inflation. It shows your actual
purchasing power.
- Calculated by subtracting the inflation
rate (as a percentage) from your nominal income.
- Example: If your nominal income
increased by 5%, but inflation is 10%, your real income has decreased
by about 5%.
- Disposable Income:
The income you have left to spend after paying direct taxes
(like income tax) from your Real or Nominal Income.
In Simple Words:
- Factor Cost
is producer's cost; Market Cost adds indirect taxes. India uses
Factor Cost due to tax complexities, but GST is changing this.
- Constant Price
removes inflation; Current Price includes inflation. India uses
Constant Price to track real growth and poverty accurately because of
fluctuating inflation. Developed countries often use Current Price due to
stable, low inflation.
- Nominal Income
is your paycheck; Real Income is your paycheck's buying power after
inflation; Disposable Income is what's left after taxes.
Understanding these cost and
price concepts is crucial for correctly interpreting national income figures
and economic growth!