What are the Factors of Production?
Factors of production in economics refer to the inputs one needs to make or produce a good or service. For any investor or business, it is very important to know the factors of production, as those who control these factors usually command more wealth. Mainly there are four factors of production: land, labor, entrepreneurship, and capital.
In a capitalist economy, it is usually the business owners and investors that own most of these factors. And in a socialist economy, it is the government that holds most of these factors.
A point to note is that all the factors of production share a co-relation and, thus, impact each other. For instance, the availability of more capital can encourage more entrepreneurship. And this will push up the demand for land and labor.
Let’s take a look at each of the factors of production in detail.
Land is a broad term as it encompasses all the natural resources on our lands, such as wood, water, oil, gold, and more. Moreover, land includes both renewable (timber) and non-renewable resources (oil and gold). Some of the resources, however, have a limited supply.
After humans change the form of these resources, the input becomes a capital good. For instance, crude oil is a natural resource, but gasoline is a capital good.
On the other hand, there are different uses of land as a factor of production. It can take several forms, such as agricultural, commercial real estate, and more. Businesses can use the land to extract and refine natural resources, such as gold and oil. In the case of agricultural land, farming and cultivation boost the value and utility of the land.
Though the land is crucial for almost all types of business, its importance may vary by industry. For instance, a new tech company may not need any land initially, but for a real estate company, the land is the single most important input.
Usually, owners of land earn income in the form of rent.
Labor means an individual’s physical and mental efforts to make a product or offer a service. Similar to land, there can be several forms of labor. For instance, a construction worker working at a hotel site will come under labor, as well as a waiter and receptionist that work in the hotel. In a software company, the work by developers and project managers will come under labor. Even the work by an artist will come under labor.
Income for labor is usually in the form of wages. There can be uneducated and untrained workers and skilled and trained workers. Payment to labor depends on their skill and training. For instance, wages for uneducated and untrained workers are usually less than those of skilled and trained workers—nations with abundant labor experience have more productivity and efficiency. China and India are good examples of this.
Labor as a factor of production has the following characteristics:
- It is heterogeneous. This means the efficiency and quality of work vary from person to person. There could be several reasons for this, such as differences in skills, education, training, work environment, etc.
- Labor is perishable. It means that one can’t save or store labor. Or, if labor doesn’t work for a day, then the time lost can’t be recovered by working another day.
- There is a close relationship between labor and human efforts. It means many humane factors help to boost labor productivity. These factors include safe working conditions, flexible work schedules, and more.
Capital primarily refers to money. This factor doesn’t direct directly result in production. Instead, it allows the owners and managers to buy land and other capital goods and pay for the labor. Owners of capital earn income in the form of interest.
Apart from money, capital also means capital goods, such as equipment, computers, and more. We call these capital goods because they are part of the production process and help in productivity. Only goods that are used for official purposes (not private) will be capital goods. For instance, a car used for delivery is a capital good, but a car for leisure travel is not.
Following are the main features of capital as a production:
- Unlike other factors of production, humans are the creator of capital. For instance, humans make machines, equipment, and other capital goods.
- One can save or store capital for a long time. However, capital or capital goods depreciate over time. For example, machinery would lose value or depreciate as it gets old.
- Unlike land, capital is a mobile factor of production. One can easily transport it from one place to another.
This factor collects control and manages all other factors of production to come up with a product or service. Entrepreneurship basically involves coming up with innovative ideas and putting plans into action using all other factors of production. It is the entrepreneurs who take all the risks. Profit is the reward for entrepreneurs.
Entrepreneurs are very important for the economic growth of a nation. This is the reason why countries create policies to make it easier for entrepreneurs to start a new company. Moreover, the government mainly focuses on providing all types of facilities to small companies. It is because these are the companies that have the potential to turn into the mega company one day. Also, small companies constitute a large portion of the economy and offer employment to a significant portion of the population.
Ownership of Factors of Production
It is generally assumed that the households own the factors of production. And, it is the households that lend or lease them to the entrepreneurs or companies. Such an assumption, however, isn’t practical. In reality, ownership of all factors of production, except for labor, varies on the basis of industry and the economic system.
For example, a real estate company is more likely to own land because of its nature of work. But a retail firm is likely to take the land on a lease. Similarly, an entrepreneur can always take money (capital) from a third party in the form of a loan.
Talking about ownership varying on the basis of the economic system, the government is more likely to own the factors of production (land and capital) in a socialist economy. And in a capitalist model, it is the private firm and individuals who own the majority of the factors of production. Similarly, in the case of communism, ownership belongs to everyone but via government.
Is Technology a Fifth Factor?
Though technology isn’t the fifth factor officially, many consider it to be one. In the current world, technology plays a very important role in coming up with a product or service.
Technology is a very broad term. It could include software, hardware, or a combination of two to make the production process more efficient. So, it won’t be wrong to say that technology helps in the efficient utilization of all four factors of production. For instance, the use of robots in production can help a company to raise productivity, as well as reduce costs. Technology also helps an entrepreneur to make better decisions.
TFP (total factor productivity) or the ‘Solow residual’ is a good measure of technology as a factor production. Economists see total factor productivity (TFP) as a key ingredient that drives economic growth for a nation.
Together, all the factors of production determine the productivity of a country. Thus, for economists, policymakers, and businesses, it is very important to understand the relative availability and accessibility of these factors. Economists and policymakers can use their knowledge o the factors of production to come up with forecasts, as well as create economic and monetary policies. For businesses, knowing about the factors of production can help them attain long-term success.