Market and Basic Prices
Definition
Market prices: the prices buyers actually pay, which include taxes on products and are net of subsidies on products.
Basic prices: the prices producers actually receive, before taxes on products are added and after subsidies on products are included.
Taxes and subsidies on products: a tax on a product (such as VAT) raises the price buyers pay, while a subsidy lowers it; both drive a wedge between market and basic prices.
Two Ways to Value Output
- Market prices are what buyers actually pay, including taxes on products and net of subsidies on products.
- Basic prices are what producers keep from each sale.
- The two differ because taxes and subsidies drive a wedge between what buyers pay and what producers keep.
Making the Adjustment
Reference formula
basic prices=market prices−taxes on products+subsidies on products \text{basic prices} = \text{market prices} - \text{taxes on products} + \text{subsidies on products} basic prices=market prices−taxes on products+subsidies on products- A tax on a product, such as UK VAT at 20%, raises the market price above what the producer receives.
- So subtract taxes on products to move from market prices towards basic prices.
- A subsidy on a product, such as support for public transport, lowers the fare buyers pay below what the producer actually receives.
- So add subsidies on products to complete the move to basic prices.
Key Idea
- Basic prices = market prices − taxes on products + subsidies on products.
- Basic prices strip out government distortions to show the true value producers receive.
Example
- GDP at market prices is £900 billion, taxes on products are £80 billion and subsidies on products are £20 billion.
- GDP at basic prices is £840 billion: lower than the market-price figure because taxes on products exceed subsidies.
Why It Is Useful
- Basic prices reflect the value of production without tax and subsidy distortions.
- This makes comparisons fairer when tax or subsidy rates change over time or differ between economies.
- It depends on the mix, though: where subsidies exceed product taxes, the basic-price figure will lie above the market-price one.
Exam technique
- Recall the direction: − taxes and + subsidies to reach basic prices.
- To reverse it, + taxes and − subsidies to return to market prices.
Common Mistake
- Do not + taxes and − subsidies when moving to basic prices, as that reverses the correct signs.
- Remember a subsidy makes the basic price higher than the market price.
Self review
- Define basic prices.
- How do market prices differ from basic prices?
- How do you adjust market prices to basic prices?
- Why is a subsidy added rather than subtracted?
