The factors of production are the building blocks of any economy – the inputs that we use to produce goods and services in order to make an economic profit.
The factors of production are divided into the following four categories:
– Land: plus anything that comes from the land, including any natural resource used to produce goods and services. Examples of common land or natural resources are forests, coal, natural gas, copper, oil and water.
Forests are among the renewable resources, while non-renewable ones include oil or natural gas. Resource owners earn income in return for land.
According to the Bank of England, in the short to medium term, estimates of a country’s productivity can be affected by the intensity with which factors of production are utilized.
– Labor: the effort that humans contribute to the production of goods and services. Resources include, for example, the work done by the engineer who designed a bridge that your commuting car goes across everyday as well as the waiter who brings your meal at a local restaurant.
Any person who has been paid for work done has contributed labor resources to the production of goods or services. Labor resource income is called wages and is, for most people, their largest source of income.
– Capital: includes machinery, tools and buildings that we use to produce goods and services. Examples include computers, delivery vehicles, conveyor belts, forklift trucks, hammers, etc. The type of capital used depends on the work being done.
For example, a teacher uses desks, a whiteboard, text books to deliver education services, while a doctor uses an examination room, a stethoscope and other medical devices to provide medical services.
The income of capital resource owners is called interest.
The process of production combines various inputs (Factors of Production) in order to make something for consumption (the output).
– Entrepreneurship (enterprise): a person who combines the other factors of production – capital, labor and land – to earn a profit. The most successful entrepreneurs are people who find new ways to produce goods or deliver services – innovators. Innovators also create new goods and services and bring them to the market.
Many of the innovations we see around us would not be there today had it not been for entrepreneurs – such as Bill Gates and Henry Ford – who combined capital, labor and land in new ways.
Entrepreneurs have helped build some of the world’s largest corporations, as well as many small businesses in your neighborhood. They thrive in economies where they have the freedom to set up businesses and purchase resources freely. The entrepreneur earns profit.
Factor subdivisions are known as the 4 Ms: management, machines, materials and money. Over the past few years, knowledge has become recognized as distinct from labor, and potentially a factor of production in its own right.
Why is money not a factor of production?
Why isn’t money mentioned as part of a factor of production- isn’t it a type of capital? The Federal Reserve Bank of St. Louis says that in this case it does not class money as capital because it is not a productive resource.
We can use money to purchase capital – devices that help produce things – but money itself does not produce anything. You cannot use a $50 bill to hammer a nail into wood or transport a shipment of merchandise (in this context, merchandise refers to goods).
Money is just the facilitator of trade, it is not a productive resource in itself.
John Maynard Keynes (1883-1946), a British economist whose ideas fundamentally changed the economic policies of governments, once said: “It is preferable to regard labor, including, of course, the personal services of the entrepreneur, and his assistants, as the sole factor of production, operating in a given environment of technique, natural resources, capital equipment and effective demand. This is why we have been able to take labour as the sole physical unit which we require in our economic system, apart from units of money and of time.”
Availability of goods and services and factors of production
The availability of goods and services go hand in hand with the availability or scarcity of factors of production used to make or deliver them.
Consider a man’s cotton shirt. The cotton is grown on the land, which uses water and other resources. Both the land and water are limited resources that could have been used to grow different crops.
The workers who cut the cotton and make the shirt in the factory are limited labor resources – they could have been producing something else. The machines and tools in the shirt factory are limited capital resources that could have been used to produce other goods.
Resources are limited; their scarcity means that producing some goods and services leaves others unproduced.
Ludwig von Mises (1881-1973), a theoretical Austrian School economist whose writings have significantly influenced the libertarian movement in the USA, once said: “It is inherent in the nature of the capitalistic economy that, in the final analysis, the employment of the factors of production is aimed only toward serving the wishes of consumers.” (Image: Wikipedia)
Primary and secondary factors of production
The are two kinds of factors of production. Primary factors include land, labor and capital goods applied to production. They facilitate production but do not become part of the product and do not become significantly transformed in the production process.
Land includes both the site of production as well as the natural resources above or below the soil.
Secondary factors include materials and energy – they are secondary because they are obtained from land, labor and capital.
Different interpretations of factors
Determining which factor is the most important depends on your school of economics. In the Austrian view – a view shared by most ‘free market’ economists – the most important (primary) factor of production is the entrepreneur’s time, which when combined with other factors, determines how much is produced.
Other schools of thought insist that entrepreneurship is simply a kind of labor or human capital and should not be treated separately.
The Marxian school sees labor as the primary factor of production, arguing that it is required to produce capital goods and to utilize the gifts of nature.
The ft.com/lexicon defines the factors of production as:
“The elements used to produce economic goods, in other words, land, labour, capital and enterprise.”
Video – Factors of Production