Investment, Depreciation and Net Indirect Taxes

Gross vs net investment, depreciation and its causes, net indirect taxes, and factor cost vs market price.

Notes

Gross Investment, Net Investment and Depreciation

Gross Investment is the addition to the stock of capital before making allowance for depreciation. Capital stock consists of fixed assets and unsold stock (inventories).

Net Investment

$$\\text{Net Investment} = \\text{Gross Investment} - \\text{Depreciation}$$

Net Investment is the actual addition made to the capital stock of the economy in a given period. Increase in net investment leads to an increase in the productive capacity of the economy.

Depreciation (Consumption of Fixed Capital) refers to a fall in the value of fixed assets due to:

Normal wear and tear
Passage of time
Expected obsolescence (change in technology)

Gross Value

$$\\text{Gross Value} = \\text{Net Value} + \\text{Depreciation}$$

Gross-Net-Depreciation Cycle

Gross Investment

(-) Depreciation

Net Investment

(+) Depreciation

Gross Investment

Depreciation is also known as:(i) Current Replacement Cost(ii) Replacement cost of Fixed Capital(iii) Capital Consumption Allowance

Depreciation Reserve Fund:Because fixed assets need replacement, provision is made on an annual basis.Example: Machine purchased for 10,00,000 with 10-year lifetime = annual provision = 1,00,000.This accumulated fund is called the Depreciation Reserve Fund.

Depreciation vs. Capital Loss
Aspect	Depreciation	Capital Loss
Meaning	Fall in value due to normal wear and tear, passage of time, or expected obsolescence	Loss in value due to unforeseen obsolescence, natural calamities, thefts, accidents
Provision	Provision made (Depreciation Reserve Fund) - expected loss	No provision - unexpected loss; insurance may minimise loss
Production	Does not hamper the production process	Hampers the production process

Net Indirect Taxes (NIT)

Net Indirect Taxes refer to the difference between indirect taxes and subsidies.

Net Indirect Taxes

$$\\text{NIT} = \\text{Indirect Taxes} - \\text{Subsidies}$$

Indirect Taxes are taxes imposed by the government on the production and sale of goods and services.Examples: GST, Basic Customs Duty, Central Excise, VAT on Petroleum Products, Electricity Duties, Stamp Duty.

Indirect tax increases the market price of the product.Example: Cost of producing speakers = 500. GST of 10% = Market price = 550.

Subsidies are financial assistance provided by the government to producers to fulfil social welfare objectives.Granted to promote exports or encourage firms to set up industries in backward areas.Subsidies are opposite to indirect taxes - they reduce the market price.Subsidy is a Transfer Payment (financial assistance without productive service in return).

Market Price

$$\\text{MP} = \\text{FC} + \\text{NIT}$$

Real-World Example: Petrol & Diesel Prices in Delhi (Nov 1, 2024)

Petrol

Base Price54.93

Freight0.24

Excise Duty19.90

Dealer Commission4.30

VAT15.40

Retail Price94.77

Diesel

Base Price55.89

Freight0.22

Excise Duty15.80

Dealer Commission2.93

VAT12.83

Retail Price87.67

Notice how Excise Duty + VAT (indirect taxes) make up a large portion of the final price.

Solved Example

Problem

Calculate Net Indirect Taxes (NIT) in the following cases:

Solution

Case 1: (-)100; Case 2: 250; Case 3: 80

Key Insight:The concept of NIT is relevant only in three-sector and four-sector economies.In a two-sector economy (households + firms), indirect taxes and subsidies do not arise.