Factor cost is the total cost of each item needed to produce a good, including raw materials, labor, and indirect costs. This method allows businesses to charge consumers the total cost of production, but inefficiencies can be passed on to consumers. However, it can also help consumers avoid indirect taxes and government subsidies can offset high input costs. This method seeks to place true economic value on goods produced and can help new industries with emerging technology or low market demand.
Factor cost represents the full cost of each individual item required to produce a good. These costs may include raw materials required to produce an asset, labor required to transform raw materials into finished products, and indirect costs assigned to the assets, such as electricity, rent, or other fixed costs. Using factor cost (also known as factor or production cost) for goods and services is quite different from allowing the market to set a price for products.
The factors of production consist of land, labor and capital. These items are needed to produce goods and services, with most businesses having to purchase or spend time or money gathering inputs. Under factor cost principles, a business can charge consumers the total cost of production when exchanging goods in an economic transaction. A big problem with this costing process is that companies can pass inefficiencies on to consumers. For example, a consumer might want to purchase a widget for $5 United States Dollars (USD). However, no company can produce a widget for less than $7 USD based on ongoing costs for inputs. If this increased cost is the result of a company’s poor manufacturing processes, the consumer must pay for this inefficiency.
An advantage of calculating the cost of goods using the factor cost procedure is the ability of consumers to avoid paying indirect taxes. Many companies add the costs of doing business — such as business licenses, federal taxes, or other unavoidable government fees — to the goods and services they produce. These costs will unnaturally increase the cost of consumer products and result in fewer consumers to spend on goods and services. Government subsidies can also help reduce the factor cost of goods and services. The goods subsidy will help companies recover some costs before selling products to consumers. Through a subsidy process, governments can attempt to offset the high costs associated with inputs, thereby extending the purchasing power of money held by consumers.
Factor cost as the base rate for goods and services often seeks to place true economic value on the goods produced. Profits are low or may not exist if a company is unable to control its costs. In this scenario, government subsidies are a company’s way of earning capital to continue producing goods and services. New industries with emerging technology or other goods with low market demand can be difficult for companies to produce. Governments further help these technologies by offsetting the factor costs associated with the factors of production.
Protect your devices with Threat Protection by NordVPN
