In order to operate efficiently, businesses have to deal with a number of costs as they aim to provide the best goods and services to its customers. The final consumer, on the other hand, will be spoiled for choices when it comes to choosing the desired products and services. However, the willingness to buy will be further dependent upon his or her financial capability. In the middle of the buyer and sellers is the government, which is aiming to generate revenue in the form of taxes.
Factor cost and market price are two concepts, which are of great importance to an individual, a business and the government. Factor cost plainly deals with the producer side of the story and the unit cost he or she incurs by applying various inputs to the production process, known as the factors of production – land, labor, capital and entrepreneurship. These inputs will directly determine the quantity of output produced.
For instance, a business will rent the land, pay wages to the labour and will use capital to acquire raw material and then combine all these factors to produce the desired output.
Once the output is produced, it will be sold in the market at a set market price. This market price will be determined by the consumer and producer’s willingness to buy and sell the product respectively.
In economics, this is usually referred to as the forces of demand and supply. When the two equate, the price is determined. However, in reality, many external factors also pay a pivotal role such as the price charged by the competitors and the government’s cut, which comes in the form of taxes.
Therefore, if you are willing to pay $100 for something, the producer will only receive the amount to compensate for the factor cost, while the remaining will be pocketed by the government. Factor cost and market price are thus two related concepts with different implications. Market price incorporates the factor cost but may also account for other external changes.