Factor Cost:

• Factor costs are the actual production costs at which goods and services are produced by firms and industries in an economy. They are the cost of all factors of production such as land, labor, capital, energy, raw materials like steel, etc that are used to produce a given quantity of output in an economy.
• For e.g. A bread is being made in a bakery. The raw material used is  wheat (it costs Rs.50), one person  is involved in making it (he charges Rs.10). Now the factor cost of the bread is going to be  Rs.50+Rs.10=Rs.60. (We are ignoring the other charges for simplicity like the rent of the place where  bakery functions, the electricity bill etc).

Market Price:

• It  refers to the actual transacted price and thus includes the indirect taxes(Product Taxes) which a government levies and the subsidies (Product Subsidies)which the government gives on the products.
• Thus there are two changes we make to the factor cost to arrive at the Market Price. We need to add the indirect taxes and subtract the subsidies given by the government.
• Once a product is produced and it leaves the factory gate,  Market Price comes into play during the billing process, where the indirect taxes levied by the government are added and this is the final cost the consumer has to pay for the product.
• Subsidies are subtracted because it reduces the cost of production and thus the consumer has to pay less.

Price:

• Income can be derived at two prices, constant and current.
• The difference in the constant and current prices is only that of the impact of inflation. Inflation is considered stand still at a year of the past (this year of the past is also known as the ‘base year’) in the case of the constant price, while in the current price, present day inflation is added.
• Current price is, basically, the maximum retail price (MRP) which we see printed on the goods selling in the market.
• As per the new guidelines the base year in India has been revised from 2004–05 to 2011–12 (January 2015). I
• ndia calculates its national income at constant prices—so is the situation among other developing economies, while the developed nations calculate it at the current prices. Though, for statistical purposes the CSO also releases the national income data at current prices. Why?
• Basically, inflation has been a challenging aspect of policymaking in India because of its level (i.e., range in which it dwindles) and stability (how stable it has been).
• In such situations growth in the income levels of the population living below the poverty level (BPL) can never be measured accurately (due to higher inflation the section will show higher income) and the government will never be able to measure the real impact of its poverty alleviation programmes.

Other common Price Indices are the
Consumer Price Index (CPI) and  the Wholesale Price Index (WPI).
Consumer Price Index (CPI)
- CPI (Rural,Urban,Combined) is released by the Central Statistics Office (CSO)in the Ministry of Statistics and Programme Implementation.
- In India, RBI uses CPI (combined) released by CSO for inflation targeting purpose (This would be covered in a detailed manner in later units).
- Base year for CPI (Rural, Urban, Combined) is 2011-12 (In exams if there are two separate options 2011, 2012; the correct option is 2012. It has to be  chosen as the base year).
- The number of items in CPI basket include 448 in rural  and 460 in urban. The items in CPI are divided into 6 main groups as follows: The six broad categories are:

• Food and Beverages
• Pan, Tobacco and Intoxicants
• Clothing and Footwear
• Housing
• Fuel and Light
• Miscellaneous

Now, while calculating the CPI (Rural), the component of ‘Housing’ has no weightage. The weightage for CPI (Combined) is as follows:

• Food and Beverages: 45.86%
• Pan, Tobacco and Intoxicants: 2.38%
• Clothing and Footwear: 6.53%
• Housing: 10.07%
• Fuel and Light: 6.84%
• Miscellaneous: 28.32%

Wholesale Price Index:
- Wholesale Price Index (WPI) is computed by the Office of the Economic Adviser in Ministry of  commerce & Industry, Government of India.
- It was earlier released on weekly basis for Primary Articles and Fuel Group. However, since 2012,  this practice has been discontinued. Currently, WPI is released monthly.
- The current base year for WPI is 2011-12 (earlier it was 2004-05).
- Number of Items: Earlier, there were 676 items in WPI •
- The number of items covered in the new series of the WPI has increased from 676 to 697.  Overall, 199 new items have been added and 146 old items have been dropped.
- These items are divided into three broad categories: (1) Primary Articles (2) Fuel & power and (3) Manufactured Products. It does not include services.
- Under the new series of WPI,weight of manufactured items has decreased to 64.2 per cent from 64.9 per cent in old series. Similarly, the weight of fuel and power has decreased to 13.1 per cent from 14.9 per cent. On the other hand, the weight of primary items has increased to 22.6 per cent from 20.1 percent

Nominal and Real Income and Disposable Income.

• Here, one important aspect of income needs to be understood. Income of a person has three forms—the first form is nominal income (the wage someone gets in hand per day or per month), the second form is real income (this is nominal income minus the present day rate of inflation—adjusted in percentage form), and the last one is the disposable income (the net part of wage one is free to use which is derived after deducting the direct taxes from the real/nominal income, depending upon the need of data).
• What happens in practice is that while the nominal income might have increased by only 5 per cent, it looks 15 per cent if the inflation is at the 10 per cent level.
• Unlike India, among the developed nations, inflation has been around 2 per cent for many decades (it means it has been at lower levels and stable, too. This is why the difference between the incomes at constant and current prices among them are narrow and they calculate their national income at current prices. They get more reliable and realistic data of their income).

TAXES AND NATIONAL INCOME

• While accounting/calculating national income the taxes, direct and indirect, collected by the government, needs to be considered. In the case of India, to the extent the direct taxes (individual income tax, corporate income tax, i.e., the corporate tax, divident tax, interest tax, etc.) are concerned, there is no need of adjustment whether the national income is accounted at factor cost or market cost.
• This is so because at both the ‘costs’ they have to be the same; besides these taxes are collected at the income of source of the concerned person or group.
• But the amount of indirect taxes (cenvat, customs, central sales tax, sales tax/vat, state excise, etc.) needs to be taken into account if the national income is accounted at ‘factor cost’ (which is the case with India). If the national income is calculated at factor cost then the corpus of the total indirect taxes needs to be deducted from it.
• This is because, indirect taxes have been added twice: once at the point of the people/group who pay these taxes from their disposable income while purchasing things from the market, and again at the point of the governments (as their income receipts).
• Collection/source of indirect taxes are the ‘disposable income’ (which individuals and companies have with them after paying their direct taxes—from which they do any purchasing and finally, the indirect taxes reach the government).
• Thus, if the national income is calculated at factor cost, the formula to seek it will be: National Income at Factor Cost = NNP at Market Cost – Indirect Taxes However, if the national income is being derived at ‘market cost’, the indirect taxes do not need to be deducted from it. In this case, the government do not have to add their income accruing from indirect taxes to the national income. It means, that the confusion in the case of national income accounting at factor cost is only related to indirect taxes.

SUBSIDIES AND NATIONAL INCOME

• Similar to the indirect taxes, the various subsidies which are forwarded by the governments need to be adjusted while calculating national income.
• They are added to the national income at market cost, in the case of India. Subsidies are added in the national income at market cost to derive the national income at factor cost.
• This is because the price at which subsidised goods and services are made available by the government are not their real factor costs (subsidies are forwarded on the factor costs of the goods and services) otherwise we will have a distorted value (which will be less than its real value).
• Thus, the formula will be: National Income at Factor Cost = NNP at Market Cost + Subsidies If the national income is derived at the market cost and governments forward no subsidies there is no need of adjustments for the subsidies, but after all there is not a single economy in the world today which does not forward subsidies in one or the other form.

Putting ‘indirect taxes’ and ‘subsidies’ together, India’s National Income will thus be derived with the following formula (as India does it at factor cost):
National Income at Factor Cost = NNP at Market Cost – Indirect Taxes + Subsidies.

Methods to estimate National Income:
1.Output Method/ Product Method
2.Expenditure Method
3.Income Method

Circular Flow of Income:
Before, explaining each one in detail, let us consider a simple economy ( without a government, external  trade or any savings)
- Here we have individuals working for the firms (Business), they receive their wages from the firms in exchange of their services.
- In this simplified economy, there is only one way in which the individuals (households) may dispose off their earnings–by spending their entire income on the goods and services produced by the domestic firms.
- In other words, factors of production use their remunerations to buy the goods and services which they assisted in producing.
- The aggregate consumption by the households of the economy is equal to the aggregate expenditure on goods and services produced by the firms in the economy.
- The entire income of the economy, therefore, comes back to the producers in the form of sales revenue.

Product Method:
- In this method, national income is measured as a flow of goods and services. We calculate money value of all final goods and services produced in an economy during a year. Final goods here refer to those goods which are directly consumed and not used in further production process.
- Goods which are further used in production process are called intermediate goods. In the value of final goods, value of intermediate goods is already included therefore we do not count value of intermediate goods in national income otherwise there will be double counting of value of goods.
- The money value is calculated at market prices so sum-total is the GDP at market prices.

Expenditure Method:
In this method, national income is measured as a flow of expenditure. GDP is sum-total of private consumption expenditure. Government consumption expenditure, gross capital formation (Government and private) and net exports (Export-Import).

Income Method:
- Under this method, national income is measured as a flow of factor incomes. There are generally four factors of production labour, capital, land and entrepreneurship. Labour gets wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as their remuneration.
- Besides, there are some self-employed persons who employ their own labour and capital such as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of all these factor incomes is called NDP at factor costs.
- The three methods must yield the same results because the total expenditure on goods and services (Gross National Expenditure) must be equal to the value of goods and services produced (Gross National product) which must be equal to the total income paid to factors that produced these goods and services.