Subsidies and National Income: Simple Notes
- Subsidies Also Matter:
Just like taxes, subsidies given by the government also need to be
considered when calculating national income.
- What are Subsidies?
Subsidies are like financial help given by the government to
producers or consumers. They reduce the cost of goods and services,
often to make them more affordable or to support certain industries (like
agriculture, essential goods, etc.).
- Subsidies and Market Cost:
In India's case, subsidies are added to the National Income at
Market Cost to get to National Income at Factor Cost. This is the opposite
of what we do with indirect taxes (where we deduct them).
- Why Add Subsidies to Get Factor Cost?
(Correcting for Distorted Prices):
- Subsidies lower the market price
of goods and services below their actual Factor Cost.
- Subsidies are given on Factor Costs:
Governments provide subsidies to reduce the producer's input costs
(Factor Costs) or to lower the final market price.
- If we just used the lower market
price (which includes the subsidy benefit) to calculate national
income, we would get an underestimated value. The national income
would appear less than the actual value of production in terms of
factor costs.
- To get the real Factor Cost value,
we need to add back the amount of the subsidy. This
"corrects" the price to reflect the true cost of production before
the government lowered the price with a subsidy.
- Formula for National Income at Factor
Cost (with Subsidies):
National Income at Factor Cost = National Income at Market Cost + Subsidies
(Again, in the text, it's written as: NNP at Factor Cost = NNP at Market Cost + Subsidies)
- No Subsidies, No Adjustment at Market
Cost (Hypothetical): If there were no subsidies
in an economy, and we were calculating National Income at Market Cost, we
wouldn't need to worry about subsidies at all. However, the text notes
that every country in the world uses subsidies in some way.
- Combined Formula (Indirect Taxes and
Subsidies) for India (Factor Cost):
National Income at Factor Cost = National Income at Market Cost - Indirect Taxes + Subsidies - This formula combines both adjustments:
- Subtract Indirect Taxes:
Because they are included in Market Cost but are not part of Factor Cost.
- Add Subsidies:
Because they reduce Market Cost below Factor Cost, and we need to
add them back to reflect the true Factor Cost value.
In Simple Words:
- Subsidies
are government help that makes prices lower for consumers.
- When calculating National Income at Factor
Cost, we need to add subsidies back. This is because subsidies
artificially lower market prices, and we want to know the real cost
of production (Factor Cost) before the subsidy.
- So, the complete formula for India (using
Factor Cost) is: Start with Market Cost, subtract indirect taxes,
and add subsidies to get National Income at Factor Cost.
Essentially, we are adjusting
Market Cost to remove the effects of government price interventions (taxes and
subsidies) to arrive at the underlying Factor Cost of production.