Factor cost or national income by type of income is a measure of

national income A variety of measures of national income and output are used in economics to estimate total economic activity in a country or region, including gross domestic product (GDP), Gross national income (GNI), net national income (NNI), and adjusted nati ...

or output based on the cost of

factors of production In economics, factors of production, resources, or inputs are what is used in the production process to produce output—that is, goods and services. The utilised amounts of the various inputs determine the quantity of output according to the rela ...

, instead of market prices. This allows the effect of any subsidy or

indirect tax An indirect tax (such as a sales tax, per unit tax, value-added tax (VAT), excise tax, consumption tax, or tariff) is a tax that is levied upon goods and services before they reach the customer who ultimately pays the indirect tax as a part of ...

to be removed from the final measure. The concept of factor cost is focusing on the cost incurred on the factor of

production Production may refer to: Economics and business * Production (economics) * Production, the act of manufacturing goods * Production, in the outline of industrial organization, the act of making products (goods and services) * Production as a stat ...

. It can be defined as the actual cost incurred on

goods and services Goods are items that are usually (but not always) tangible, such as pens or Apple, apples. Services are activities provided by other people, such as teachers or barbers. Taken together, it is the Production (economics), production, distributio ...

produced by industries and firms is known as factor costs. Factor costs include all the costs of the factors of production to produce a given product in an economy. It includes the costs of land, labor,

capital Capital and its variations may refer to: Common uses * Capital city, a municipality of primary status ** Capital region, a metropolitan region containing the capital ** List of national capitals * Capital letter, an upper-case letter Econom ...

and raw material, transportation etc. They are used to produce a given quantity of output in an economy. The factor cost does not include the profits made by the producing firms or industries or the tax which they incur on producing those goods and services. We can simply categorize it as the cost of producing a product from unfinished

good In most contexts, the concept of good denotes the conduct that should be preferred when posed with a choice between possible actions. Good is generally considered to be the opposite of evil. The specific meaning and etymology of the term and its ...

to a semi finished good or a finished good up to the desired output level.

The role of factor costs

In a

microeconomic Microeconomics is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics focuses on the ...

analytical framework,

profit maximization In economics, profit maximization is the short run or long run process by which a firm may determine the price, input and output levels that will lead to the highest possible total profit (or just profit in short). In neoclassical economics, ...

by the firm makes the desired level of

depend on the cost of labour and capital factors. Firms have a choice among several possible productive combinations, and choose the one that minimizes its costs, and thus maximizes its profits. In the short term, when the level of production is constrained by market outlets, it is the relative cost of the factors of production that is taken into account. Thus, if the cost of capital rises in relation to wage costs, it is in the firm's interest to limit

investment Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

expenditure by substituting a greater quantity of labour for capital. In the long term, where the production programme is not constrained by market outlets, it is the real cost of each factor that is taken into account in the investment decision.

Empirical studies Empirical research is research using empirical evidence. It is also a way of gaining knowledge by means of direct and indirect observation or experience. Empiricism values some research more than other kinds. Empirical evidence (the record of one ...

at the

macroeconomic Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as output/ GDP ...

level have long failed to show the impact of factor costs on investment (Dormond 1977). This relationship between the cost of production factors and the level of investment appears to be theoretically sound. The concept of "user cost of capital" has been integrated by Crépon and Gianella. They carried out a study by integrating many elements: bank interest rates specific to each company,

balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...

structure, taxation of companies and

shareholders A shareholder (in the United States often referred to as stockholder) of corporate stock refers to an individual or legal entity (such as another corporation, a body politic, a trust or partnership) that is registered by the corporation as the ...

, inflation and depreciation. This indicator provides a rigorous assessment of the effective cost of capital. Over the period considered in this study (1984-1997), the cost of capital fell significantly, mainly as a result of the easing of real interest rates. Taxation contributed only marginally to the decline in the user cost of capital. Its variations have been erratic: corporate taxes declined from the mid-1980s to 1995, but the tax burden increased thereafter. From this study they were able to distinguish two effects of a variation in the user cost of capital: a

substitution effect In economics and particularly in consumer choice theory, the substitution effect is one component of the effect of a change in the price of a good upon the amount of that good demanded by a consumer, the other being the income effect. When a ...

and a profitability effect. An increase in the

cost of capital In economics and accounting, the cost of capital is the cost of a company's funds (both debt and equity), or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate ne ...

should encourage firms to substitute labour for capital, thus increasing the demand for labour (substitution effect). At the same time, however, a rise in the cost of capital increases the unit cost of production for the firm, thereby raising its prices, and may reduce the demand for capital (profitability effect). The proposed estimates suggest that the profitability effect dominates the substitution effect. An increase in the cost of capital would therefore lead to a fall in demand for both factors of production, capital and labour, and thus penalise employment. When calculating national income

indirect taxes An indirect tax (such as a sales tax, per unit tax, value-added tax (VAT), excise tax, consumption tax, or tariff) is a tax that is levied upon goods and services before they reach the customer who ultimately pays the indirect tax as a part of ma ...

are deducted while subsidies are added

References

https://www.persee.fr/doc/estat_0336-1454_2001_num_341_1_7472 Gross domestic product National accounts {{econ-stub