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Factors of Production - The Economic Lowdown Podcast & Transcript
The four factors of production are land, labor, capital and entrepreneurship Download the image
In economics, factors of production are the resources people use to produce goods and services; they are the building blocks of the economy. Economists divide the factors of production into four categories: land, labor, capital, and entrepreneurship .
This episode of our Economic Lowdown Podcast Series explains the four factors of production with examples. Listen to the audio or read more in the transcript below.
What are factors of production?
Factors of production are resources that are the building blocks of the economy; they are what people use to produce goods and services. Economists divide the factors of production into four categories: land, labor, capital, and entrepreneurship.
What are some examples of land as a factor of production?
Land includes any natural resource used to produce goods and services; anything that comes from the land. Some common land or natural resources are water, oil, copper, natural gas, coal, and forests. Land resources are the raw materials in the production process. These resources can be renewable, such as forests, or nonrenewable such as oil or natural gas.
What are some examples of labor as a factor of production?
Labor is the effort that people contribute to the production of goods and services. Labor resources include the work done by the waiter who brings your food at a local restaurant as well as the engineer who designed the bus that transports you to school. It includes an artist's creation of a painting as well as the work of the pilot flying the airplane overhead. If you have ever been paid for a job, you have contributed labor resources to the production of goods or services.
What are some examples of capital as a factor of production?
Think of capital as the machinery, tools and buildings humans use to produce goods and services. Some common examples of capital include hammers, forklifts, conveyer belts, computers, and delivery vans. Capital differs based on the worker and the type of work being done. For example, a doctor may use a stethoscope and an examination room to provide medical services. Your teacher may use textbooks, desks, and a whiteboard to produce education services.
What are some examples of entrepreneurship as a factor of production?
An entrepreneur is a person who combines the other factors of production - land, labor, and capital - to earn a profit. The most successful entrepreneurs are innovators who find new ways to produce goods and services or who develop new goods and services to bring to market. Without the entrepreneur combining land, labor, and capital in new ways, many of the innovations we see around us would not exist. Entrepreneurs are a vital engine of economic growth helping to build some of the largest firms in the world as well as some of the small businesses in your neighborhood. Entrepreneurs thrive in economies where they have the freedom to start businesses and buy resources freely.
The factors of production are resources that are the building blocks of the economy; they are what people use to produce goods and services. Economists divide the factors of production into four categories: land, labor, capital, and entrepreneurship.
The first factor of production is land, but this includes any natural resource used to produce goods and services. This includes not just land, but anything that comes from the land. Some common land or natural resources are water, oil, copper, natural gas, coal, and forests. Land resources are the raw materials in the production process. These resources can be renewable, such as forests, or nonrenewable such as oil or natural gas. The income that resource owners earn in return for land resources is called rent.
The second factor of production is labor. Labor is the effort that people contribute to the production of goods and services. Labor resources include the work done by the waiter who brings your food at a local restaurant as well as the engineer who designed the bus that transports you to school. It includes an artist's creation of a painting as well as the work of the pilot flying the airplane overhead. If you have ever been paid for a job, you have contributed labor resources to the production of goods or services. The income earned by labor resources is called wages and is the largest source of income for most people.
The third factor of production is capital. Think of capital as the machinery, tools and buildings humans use to produce goods and services. Some common examples of capital include hammers, forklifts, conveyer belts, computers, and delivery vans. Capital differs based on the worker and the type of work being done. For example, a doctor may use a stethoscope and an examination room to provide medical services. Your teacher may use textbooks, desks, and a whiteboard to produce education services. The income earned by owners of capital resources is interest.
The fourth factor of production is entrepreneurship. An entrepreneur is a person who combines the other factors of production - land, labor, and capital - to earn a profit. The most successful entrepreneurs are innovators who find new ways to produce goods and services or who develop new goods and services to bring to market. Without the entrepreneur combining land, labor, and capital in new ways, many of the innovations we see around us would not exist. Think of the entrepreneurship of Henry Ford or Bill Gates. Entrepreneurs are a vital engine of economic growth helping to build some of the largest firms in the world as well as some of the small businesses in your neighborhood. Entrepreneurs thrive in economies where they have the freedom to start businesses and buy resources freely. The payment to entrepreneurship is profit.
You will notice that I did not include money as a factor of production. You might ask, isn't money a type of capital? Money is not capital as economists define capital because it is not a productive resource. While money can be used to buy capital, it is the capital good (things such as machinery and tools) that is used to produce goods and services. When was the last time you saw a carpenter pounding a nail with a five dollar bill or a warehouse foreman lifting a pallet with a 20 dollar bill? Money merely facilitates trade, but it is not in itself a productive resource.
Remember, goods and services are scarce because the factors of production used to produce them are scarce. In case you have forgotten, scarcity is described as limited quantities of resources to meet unlimited wants. Consider a pair of denim blue jeans. The denim is made of cotton, grown on the land. The land and water used to grow the cotton is limited and could have been used to grow a variety of different crops. The workers who cut and sewed the denim in the factory are limited labor resources who could have been producing other goods or services in the economy. The machines and the factory used to produce the jeans are limited capital resources that could have been used to produce other goods. This scarcity of resources means that producing some goods and services leaves other goods and services unproduced.
It's time to test your knowledge with a little game I like to call, Name That Resource. I will say the name of an item and you will identify it as one of the four possible resources that form the factors of production: land, labor, capital, or entrepreneurship.
- Coal... land
- Forklift... capital
- Factory... capital
- Oil... land
- Michael Dell... entrepreneur
It's time to wrap things up, but before we go, always remember that the four factors of production - land, labor, capital, and entrepreneurship - are scarce resources that form the building blocks of the economy.
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What Are Factors of Production?
How factors of production work, the 4 factors of production.
- Land As a Factor
Labor As a Factor
Capital as a factor.
- Entrepreneurship As a Factor
Connecting the Factors
Ownership of factors of production, the role of technology.
- Factors of Production FAQs
4 Factors of Production Explained With Examples
Yarilet Perez is an experienced multimedia journalist and fact-checker with a Master of Science in Journalism. She has worked in multiple cities covering breaking news, politics, education, and more. Her expertise is in personal finance and investing, and real estate.
Mira Norian / Investopedia
Factors of production are the inputs needed for creating a good or service, and the factors of production include land , labor, entrepreneurship , and capital .
Those who control the factors of production often enjoy the greatest wealth in a society. In capitalism, the factors of production are most often controlled by business owners and investors. In socialist systems, the government (or community) often exerts greater control over the factors of production.
- Factors of production is an economic term that describes the inputs used in the production of goods or services to make an economic profit.
- These include any resource needed for the creation of a good or service.
- The factors of production are land, labor, capital, and entrepreneurship.
- The state of technological progress can influence the total factors of production and account for any efficiencies not related to the four typical factors.
- Land as a factor of production can mean agriculture and farming to the use of natural resources.
Factors Of Production
The modern definition of factors of production is primarily derived from a neoclassical view of economics. It amalgamates past approaches to economic theory, such as the concept of labor as a factor of production from socialism, into a single definition.
Land, labor, and capital as factors of production were originally identified by early political economists such as Adam Smith, David Ricardo, and Karl Marx. Today, capital and labor remain the two primary inputs for processes and profits. Production, such as manufacturing, can be tracked by certain indexes, including the ISM manufacturing index .
There are four factors of production—land, labor, capital, and entrepreneurship.
Land As a Factor
Land has a broad definition as a factor of production and can take on various forms, from agricultural land to commercial real estate to the resources available from a particular piece of land. Natural resources, such as oil and gold, can be extracted and refined for human consumption from the land.
Cultivation of crops on land by farmers increases its value and utility. For a group of early French economists called “the physiocrats,” who predated the classical political economists , land was responsible for generating economic value.
While land is an essential component of most ventures, its importance can diminish or increase based on industry. For example, a technology company can easily begin operations with zero investment in land. On the other hand, land is the most significant investment for a real estate venture.
Labor refers to the effort expended by an individual to bring a product or service to the market. Again, it can take on various forms. For example, the construction worker at a hotel site is part of labor, as is the waiter who serves guests or the receptionist who enrolls them into the hotel.
Within the software industry , labor refers to the work done by project managers and developers in building the final product. Even an artist involved in making art, whether it is a painting or a symphony, is considered labor. For the early political economists, labor was the primary driver of economic value . Production workers are paid for their time and effort in wages that depend on their skill and training. Labor by an uneducated and untrained worker is typically paid at low prices. Skilled and trained workers are called “ human capital ” and are paid higher wages because they bring more than their physical capacity to the task.
For example, an accountant’s job requires the analysis of financial data for a company. Countries that are rich in human capital experience increased productivity and efficiency. The difference in skill levels and terminology also helps companies and entrepreneurs create corresponding disparities in pay scales. This can result in a transformation of factors of production for entire industries. An example of this is the change in production processes in the information technology (IT) industry after jobs were outsourced to countries with lower salaries.
In economics, capital typically refers to money. However, money is not a factor of production because it is not directly involved in producing a good or service. Instead, it facilitates the processes used in production by enabling entrepreneurs and company owners to purchase capital goods or land or to pay wages. For modern mainstream (neoclassical) economists, capital is the primary driver of value.
It is important to distinguish personal and private capital in factors of production. A personal vehicle used to transport family is not considered a capital good, but a commercial vehicle used expressly for official purposes is. During an economic contraction or when they suffer losses, companies cut back on capital expenditure to ensure profits. However, during periods of economic expansion, they invest in new machinery and equipment to bring new products to market.
An illustration of the above is the difference in markets for robots in China compared to the United States after the 2008 financial crisis. After the crisis, China experienced a multi-year growth cycle, and its manufacturers invested in robots to improve productivity at their facilities and meet growing market demands. As a result, the country became the biggest market for robots. Manufacturers within the United States, which had been in the throes of an economic recession after the financial crisis, cut back on their investments related to production due to tepid demand.
As a factor of production, capital refers to the purchase of goods made with money in production. For example, a tractor purchased for farming is capital. Along the same lines, desks and chairs used in an office are also capital.
Entrepreneurship As a Factor
Entrepreneurship is the secret sauce that combines all the other factors of production into a product or service for the consumer market. An example of entrepreneurship is the evolution of the social media behemoth Meta ( META ), formerly Facebook.
Mark Zuckerberg assumed the risk for the success or failure of his social media network when he began allocating time from his daily schedule toward that activity. When he coded the minimum viable product himself, Zuckerberg’s labor was the only factor of production. After Facebook, the social media site, became popular and spread across campuses, it realized it needed to recruit additional employees. He hired two people, an engineer (Dustin Moskovitz) and a spokesperson (Chris Hughes), who both allocated hours to the project, meaning that their invested time became a factor of production.
The continued popularity of the product meant that Zuckerberg also had to scale technology and operations. He raised venture capital money to rent office space, hire more employees, and purchase additional server space for development. At first, there was no need for land. However, as business continued to grow, Meta built its own office space and data centers. Each of these requires significant real estate and capital investments.
Another example of entrepreneurship is Starbucks Corporation ( SBUX ). The retail coffee chain needs land (prime real estate in big cities for its coffee chain), capital (large machinery to produce and dispense coffee), and labor (employees at its retail outposts for service). Entrepreneur Howard Schultz, the company’s founder, provided the fourth factor of production by being the first person to realize that a market for such a chain existed and figuring out the connections among the other three factors of production.
While large companies make for excellent examples, a majority of companies within the United States are small businesses started by entrepreneurs. Because entrepreneurs are vital for economic growth, countries are creating the necessary framework and policies to make it easier for them to start companies.
The definition of factors of production in economic systems presumes that ownership lies with households, who lend or lease them to entrepreneurs and organizations. But that is a theoretical construct and rarely the case in practice. Except for labor, ownership for factors of production varies based on industry and economic system.
For example, a firm operating in the real estate industry typically owns significant parcels of land, while retail corporations and shops lease land for extended periods of time. Capital also follows a similar model in that it can be owned or leased from another party. Under no circumstances, however, is labor owned by firms. Labor’s transaction with firms is based on wages.
Ownership of the factors of production also differs based on the economic system. For example, private enterprises and individuals own most of the factors of production in capitalism. However, collective good is the predominating principle in socialism. As such, factors of production, such as land and capital, are owned and regulated by the community as a whole under socialism.
While not directly listed as a factor, technology plays a vital role in influencing production. In this context, technology has a fairly broad definition and can refer to software, hardware, or a combination of both used to streamline organizational or manufacturing processes.
Increasingly, technology is responsible for the difference in efficiency among firms. To that end, technology—like money—is a facilitator of the factors of production. The introduction of technology into a labor or capital process makes it more efficient. For example, the use of robots in manufacturing has the potential to improve productivity and output. Similarly, the use of kiosks in self-serve restaurants can help firms cut back on their labor costs.
The Solow residual , also known as "total factor productivity (TFP)," measures the residual output that remains unaccounted for from the four factors of production and typically increases when technological processes or equipment are applied to production. Economists consider TFP to be the main factor driving economic growth for a country. The greater a firm's or country's TFP, the greater its growth.
What Are the Factors of Production?
The factors of production are an important economic concept outlining the elements needed to produce a good or service for sale. They are commonly broken down into four elements: land, labor, capital, and entrepreneurship. However, commentators sometimes refer to labor and capital as the two primary factors of production. Depending on the specific circumstances, one or more factors of production might be more important than the others.
What Are Examples of the Factors of Production?
Land refers to physical land, such as the acres used for a farm or the city block on which a building is constructed. Labor refers to all wage-earning activities, such as the work of professionals, retail workers, and so on. Entrepreneurship refers to the initiatives taken by entrepreneurs, who typically begin as the first workers in their firms and then gradually employ other factors of production to grow their businesses. Finally, capital refers to the cash, equipment, and other assets needed to start or grow a business.
Are All Factors of Production Equally Important?
Depending on the context, some factors of production might be more important than others. For example, a software company that relies primarily on the labor of skilled software engineers might see labor as its most valuable factor of production. Meanwhile, a company that makes its money from building and renting out office space might see land and capital as its most valuable factors. As the demands of a business change over time, the relative importance of the factors of production will also change accordingly.
Federal Reserve Bank of San Francisco. " Sustaining China’s Economic Growth After the Global Financial Crisis ," Pages 1-2.
International Federation of Robotics. " IFR Presents World Robotics Report 2020 ."
U.S. International Trade Commission. " The Industrial Robotics Industry in China: Demand and Domestic Innovation ."
Association for Advancing Automation. " North American Robot Orders Fall 21% in 2008 ."
Meta. “ Our History: 2004 .”
Meta. “ Our History: 2011 .”
Starbucks Coffee Corporation. " About Us ."
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Factors of Production
The four factors of production are inputs used in various combinations for the production of goods and services to make an economic profit . The factors of production are land, labor, capital, and entrepreneurship.
To put it in different terms, the factors of production are the inputs needed for supply . Mainly, the factors of production consist of any resource that is used in the creation of a good or service.
Since these factors are limited by nature, and human wants are unlimited, we, as a country, face a shared decision over the efficient allocation of these scarce resources or factors of production.
History of the Concept of Factors of Production
Our understanding of the concept of factors of production is rooted for the most part in neoclassical economics. Other strains of economic theory also contribute to our current understanding, including socialism’s view of labor as one of the factors. Influential political economists like David Ricardo, Karl Marx, and Adam Smith initially labeled land, labor, and capital as the factors of production.
Factors of Production and Type of Economic System
Sometimes the type of economic system decides the ownership of the factors of production. For example, in a capitalist economy , the factors of production are owned by individuals who use them for their own profit. This table shows who owns the factors of production in four of the most important economic systems, and what these factors are valued for in each system.
The Four Factors of Production
1. Land/Natural Resources
“Land” is quite a broad category as a factor of production in that it refers to all natural resources. These resources are gifts that are given by nature. Some typical examples of natural resources are water, oil, copper, natural gas, coal, and forests. They can range from land used for agriculture to that used for commercial real estate, as well as the natural resources derived from land.
These resources can be renewable, such as forests, or nonrenewables such as oil or natural gas. The income earned from land or other such natural resources is called rent. Although land is undeniably crucial to most forms of production, just how essential it really is varies depending on the industry. For instance, land is a central focus of virtually all agriculture but is much less important to a tech company that is quite literally operating in the virtual sphere.
Land was designated as the origin of economic value by the physiocrats, a collection of French economists who came before the better-known classical political economists (Smith, Ricardo, Marx, and others).
Labor, as a factor of production, involves any human input. It is any work done by people contributing to production. The quality of labor depends on the workforce’s skills, education, and motivation. Generally speaking, the higher the quality of labor, the more productive the workforce. Labor was considered to be the main source of economic value according to early, influential political economists (several of whom are described in the first section of this article).
Examples of labor range from the very physical to primarily mental work that goes into production. On the mental side of this factor of production are laborers like artists producing art, or programmers creating software. On the more physical side of labor might be food service workers, construction workers, or factory workers.
If someone has ever paid you for a job, you have contributed labor resources to the production of goods or services. The income earned by labor resources is called wages. It is the largest source of income for most people.
In production, wages are paid based on workers’ skill levels as well as the time invested in work. Laborers with a great deal of training and education are considered to be “highly skilled” and are paid higher wages than less trained workers. So-called skilled or highly-trained workers are described as “human capital” (referencing the third factor of production, capital, described in the next section).
Nations with high levels of such human capital tend to be more efficient and productive than countries with lower levels of this valuable resource.
Here capital refers not to money (which is not a factor of production), as you might expect, but to manufactured resources such as factories and machines. These are man-made goods used in the production of other goods. Their use in commercial production is what separates them from more widely used consumer goods. Modern, mainstream/neoclassical economists typically consider capital to be the main source of value, in contrast to economists of the past, who described land or labor as such.
Some other examples of capital include hammers, forklifts, conveyor belts, computers, and delivery vans. But it is not just this kind of machinery; office furniture like conference tables and desk chairs also fall under the umbrella of capital. An increase in capital goods means an increase in the productive capacity of the economy.
The income earned by owners of capital resources is called interest.
Note that personal and private capital is distinct from the capital we are describing here. For instance, your personal vehicle is not a capital good in this sense; however, a taxi or other vehicle used in some form of business is considered to be a capital good.
When companies need to prevent falling profits, they may spend less money on capital to compensate. By contrast, when companies and, more broadly, economies are growing, they are likely to spend on capital goods so as to be able to raise levels of production.
An entrepreneur is someone who takes on the economic risk involved in bringing the other three factors of production together. Entrepreneurs are a vital engine of economic growth at all scales, helping to build many of the largest firms in the world as well as some of the small businesses in your neighborhood. Entrepreneurs help contribute to economic growth, so governments typically do their best to encourage entrepreneurship using the right combination of policies to make starting a business accessible.
The payment an entrepreneur receives is referred to as profit, and functions as a reward for the risk they take.
Most entrepreneurs start small businesses, not the big companies that we all know the names of. Of six million companies in the United States, a total of 5.8 million are small businesses. 65 percent of new jobs are created by these small businesses. Entrepreneurs can acquire the money for their new small businesses by issuing what’s known as an initial public offering on the stock market, with shares of small-cap stocks.
A Fifth Factor of Production?
Financial capital is money, credit, and so forth that helps to build wealth. It is used by individuals to create retirement portfolios, invest, make down payments on homeownership, and so forth, and by businesses to gain greater revenue. Some people describe capital finance as the fifth factor of production, but it’s not actually a factor of production. Rather, it helps to make production possible as the owners of production receive income.
Technology and the Factors of Production
Technology is not considered an official factor of production on our list, but it is significant within the realm of production. By technology, we mean hardware and/or software that works to improve and increase the efficiency of production. Technology makes firms more or less efficient (for instance, think of the growing role of advanced robots in productive efficiency) so, similarly to money, it can be considered a facilitator of the four factors of production described above.
Other Introductory Economic Terms
1. normative statements.
Normative statements are statements with values or opinions. You can think of these statements as being more subjective. For example, the statement that “outsourcing jobs is unfair because it means there are fewer local jobs” is a normative statement. This is because it is not simply factual; labeling outsourcing “unfair” is a clear value judgment.
2. Positive Statements
Positive statements are factual statements. You can think of them as being more objective. For example, the statement that “tax hikes will cut the budget deficit” is a positive statement, because it is simply stating an indisputable and quantifiable fact, rather than a value-laden opinion.
3. Free Goods
A free good is a good that is not scarce and that has zero opportunity cost . For example, air is a free good–it is available abundantly and consuming it (quite literally, by breathing!) does not require a sacrifice of other opportunities.
4. Economic Goods
Economic goods are goods and services that require scarce resources or factors of production to produce them.
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2 thoughts on “Factors of Production”
Hey pratek this seems to be helpful for those who are dreaming to become successful entrepreneur
Considering having known a little about supply and demand, and production i thought this presentation was a thoughtfull edition to further open my mind and expand my knowledge about the four factors.
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2.1 Factors of Production
- Define the three factors of production—labor, capital, and natural resources.
- Explain the role of technology and entrepreneurs in the utilization of the economy’s factors of production.
Choices concerning what goods and services to produce are choices about an economy’s use of its factors of production , the resources available to it for the production of goods and services. The value, or satisfaction, that people derive from the goods and services they consume and the activities they pursue is called utility . Ultimately, then, an economy’s factors of production create utility; they serve the interests of people.
The factors of production in an economy are its labor, capital, and natural resources. Labor is the human effort that can be applied to the production of goods and services. People who are employed or would like to be are considered part of the labor available to the economy. Capital is a factor of production that has been produced for use in the production of other goods and services. Office buildings, machinery, and tools are examples of capital. Natural resources are the resources of nature that can be used for the production of goods and services.
In the next three sections, we will take a closer look at the factors of production we use to produce the goods and services we consume. The three basic building blocks of labor, capital, and natural resources may be used in different ways to produce different goods and services, but they still lie at the core of production. We will then look at the roles played by technology and entrepreneurs in putting these factors of production to work. As economists began to grapple with the problems of scarcity, choice, and opportunity cost two centuries ago, they focused on these concepts, just as they are likely to do two centuries hence.
Labor is human effort that can be applied to production. People who work to repair tires, pilot airplanes, teach children, or enforce laws are all part of the economy’s labor. People who would like to work but have not found employment—who are unemployed—are also considered part of the labor available to the economy.
In some contexts, it is useful to distinguish two forms of labor. The first is the human equivalent of a natural resource. It is the natural ability an untrained, uneducated person brings to a particular production process. But most workers bring far more. The skills a worker has as a result of education, training, or experience that can be used in production are called human capital . Students who are attending a college or university are acquiring human capital. Workers who are gaining skills through experience or through training are acquiring human capital. Children who are learning to read are acquiring human capital.
The amount of labor available to an economy can be increased in two ways. One is to increase the total quantity of labor, either by increasing the number of people available to work or by increasing the average number of hours of work per week. The other is to increase the amount of human capital possessed by workers.
Long ago, when the first human beings walked the earth, they produced food by picking leaves or fruit off a plant or by catching an animal and eating it. We know that very early on, however, they began shaping stones into tools, apparently for use in butchering animals. Those tools were the first capital because they were produced for use in producing other goods—food and clothing.
Modern versions of the first stone tools include saws, meat cleavers, hooks, and grinders; all are used in butchering animals. Tools such as hammers, screwdrivers, and wrenches are also capital. Transportation equipment, such as cars and trucks, is capital. Facilities such as roads, bridges, ports, and airports are capital. Buildings, too, are capital; they help us to produce goods and services.
Capital does not consist solely of physical objects. The score for a new symphony is capital because it will be used to produce concerts. Computer software used by business firms or government agencies to produce goods and services is capital. Capital may thus include physical goods and intellectual discoveries. Any resource is capital if it satisfies two criteria:
- The resource must have been produced.
- The resource can be used to produce other goods and services.
One thing that is not considered capital is money. A firm cannot use money directly to produce other goods, so money does not satisfy the second criterion for capital. Firms can, however, use money to acquire capital. Money is a form of financial capital. Financial capital includes money and other “paper” assets (such as stocks and bonds) that represent claims on future payments. These financial assets are not capital, but they can be used directly or indirectly to purchase factors of production or goods and services.
There are two essential characteristics of natural resources. The first is that they are found in nature—that no human effort has been used to make or alter them. The second is that they can be used for the production of goods and services. That requires knowledge; we must know how to use the things we find in nature before they become resources.
Consider oil. Oil in the ground is a natural resource because it is found (not manufactured) and can be used to produce goods and services. However, 250 years ago oil was a nuisance, not a natural resource. Pennsylvania farmers in the eighteenth century who found oil oozing up through their soil were dismayed, not delighted. No one knew what could be done with the oil. It was not until the mid-nineteenth century that a method was found for refining oil into kerosene that could be used to generate energy, transforming oil into a natural resource. Oil is now used to make all sorts of things, including clothing, drugs, gasoline, and plastic. It became a natural resource because people discovered and implemented a way to use it.
Defining something as a natural resource only if it can be used to produce goods and services does not mean that a tree has value only for its wood or that a mountain has value only for its minerals. If people gain utility from the existence of a beautiful wilderness area, then that wilderness provides a service. The wilderness is thus a natural resource.
The natural resources available to us can be expanded in three ways. One is the discovery of new natural resources, such as the discovery of a deposit of ore containing titanium. The second is the discovery of new uses for resources, as happened when new techniques allowed oil to be put to productive use or sand to be used in manufacturing computer chips. The third is the discovery of new ways to extract natural resources in order to use them. New methods of discovering and mapping oil deposits have increased the world’s supply of this important natural resource.
Technology and the Entrepreneur
Goods and services are produced using the factors of production available to the economy. Two things play a crucial role in putting these factors of production to work. The first is technology , the knowledge that can be applied to the production of goods and services. The second is an individual who plays a key role in a market economy: the entrepreneur. An entrepreneur is a person who, operating within the context of a market economy, seeks to earn profits by finding new ways to organize factors of production. In non-market economies the role of the entrepreneur is played by bureaucrats and other decision makers who respond to incentives other than profit to guide their choices about resource allocation decisions.
The interplay of entrepreneurs and technology affects all our lives. Entrepreneurs put new technologies to work every day, changing the way factors of production are used. Farmers and factory workers, engineers and electricians, technicians and teachers all work differently than they did just a few years ago, using new technologies introduced by entrepreneurs. The music you enjoy, the books you read, the athletic equipment with which you play are produced differently than they were five years ago. The book you are reading was written and manufactured using technologies that did not exist ten years ago. We can dispute whether all the changes have made our lives better. What we cannot dispute is that they have made our lives different.
- Factors of production are the resources the economy has available to produce goods and services.
- Labor is the human effort that can be applied to the production of goods and services. Labor’s contribution to an economy’s output of goods and services can be increased either by increasing the quantity of labor or by increasing human capital.
- Capital is a factor of production that has been produced for use in the production of other goods and services.
- Natural resources are those things found in nature that can be used for the production of goods and services.
- Two keys to the utilization of an economy’s factors of production are technology and, in the case of a market economic system, the efforts of entrepreneurs.
Explain whether each of the following is labor, capital, or a natural resource.
- An unemployed factory worker
- A college professor
- The library building on your campus
- Yellowstone National Park
- An untapped deposit of natural gas
- The White House
- The local power plant
Case in Point: Technology Cuts Costs, Boosts Productivity and Profits
Selbe Lynn – Oil Platform – CC BY-NC-ND 2.0.
Technology can seem an abstract force in the economy—important, but invisible.
It is not invisible to the 130 people who work on a Shell Oil Company oil rig called Mars, located in the deep waters of the Gulf of Mexico, about 160 miles southwest of Pensacola, Florida. The name Mars reflects its otherworld appearance—it extends 300 feet above the water’s surface and has steel tendons that reach 3,000 feet to the floor of the gulf. This facility would not exist if it were not for the development of better oil discovery methods that include three-dimensional seismic mapping techniques, satellites that locate oil from space, and drills that can make turns as drilling foremen steer them by monitoring them on computer screens from the comfort of Mars. “We don’t hit as many dry holes,” commented Shell manager Miles Barrett. As a result of these new technologies, over the past two decades, the cost of discovering a barrel of oil dropped from $20 to under $5. And the technologies continue to improve. Three-dimensional surveys are being replaced with four-dimensional ones that allow geologists to see how the oil fields change over time.
The Mars project was destroyed by Hurricane Katrina in 2005. Royal Dutch Shell completed repairs in 2006—at a cost of $200 million. But, the facility is again pumping 130,000 barrels of oil per day and 150 million cubic feet of natural gas—the energy equivalent of an additional 26,000 barrels of oil.
Technology is doing more than helping energy companies track oil deposits. It is changing the way soft drinks and other grocery items are delivered to retail stores. For example, when a PepsiCo delivery driver arrives at a 7-Eleven, the driver keys into a handheld computer the inventory of soft drinks, chips, and other PepsiCo products. The information is transmitted to a main computer at the warehouse that begins processing the next order for that store. The result is that the driver can visit more stores in a day and PepsiCo can cover a given territory with fewer drivers and trucks.
New technology is even helping to produce more milk from cows. Ed Larsen, who owns a 1,200-cow dairy farm in Wisconsin, never gets up before dawn to milk the cows, the way he did as a boy. Rather, the cows are hooked up to electronic milkers. Computers measure each cow’s output, and cows producing little milk are sent to a “hospital wing” for treatment. With the help of such technology, as well as better feed, today’s dairy cows produce 50% more milk than did cows 20 years ago. Even though the number of dairy cows in the United States in the last 20 years has fallen 17%, milk output has increased 25%.
Who benefits from technological progress? Consumers gain from lower prices and better service. Workers gain: Their greater ability to produce goods and services translates into higher wages. And firms gain: Lower production costs mean higher profits. Of course, some people lose as technology advances. Some jobs are eliminated, and some firms find their services are no longer needed. One can argue about whether particular technological changes have improved our lives, but they have clearly made—and will continue to make—them far different.
Sources: David Ballingrud, “Drilling in the Gulf: Life on Mars,” St. Petersburg Times (Florida), August 5, 2001, p. 1A; Barbara Hagenbaugh, “Dairy Farms Evolve to Survive,” USA Today , August 7, 2003, p. 1B; Del Jones and Barbara Hansen, “Special Report: A Who’s Who of Productivity,” USA Today , August 30, 2001, p. 1B; and Christopher Helman, Shell Shocked, Forbes Online , July 27, 2006.
Answers to Try It! Problems
- An unemployed factory worker could be put to work; he or she counts as labor.
- A college professor is labor.
- The library building on your campus is part of capital.
- Yellowstone National Park. Those areas of the park left in their natural state are a natural resource. Facilities such as visitors’ centers, roads, and campgrounds are capital.
- An untapped deposit of natural gas is a natural resource. Once extracted and put in a storage tank, natural gas is capital.
- The White House is capital.
- The local power plant is capital.
Principles of Economics by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.
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Factors of Production
- Adverse Selection
- Contract Theory
- Efficiency Wages
- Moral Hazard
- Principal-Agent Problem
- Budget Constraint
- Budget Constraint Graph
- Income and Substitution Effect
- Indifference Curve
- Marginal Rate of Substitution
- Marginal Utility
- Revealed Preference
- Risk Preference
- Risk Reduction
- Risk-Return Trade Off
- Substitutes vs Complements
- Utility Functions
- Behavioral Economics
- Behavioural Economics and Public Policy
- Command Economy
- Consumer Rationality
- Cost-Benefit Analysis
- Economic Efficiency
- Economic Modelling
- Economic Resources
- Economic Systems
- Economic Way of Thinking
- Economic and Social Goals
- Economics as Social Science
- Graphs in Economics
- Imperfect Information
- Introduction to Economics
- Marginal Analysis
- Market Economy
- Mixed Economy
- Normative and Positive Statements
- Production Possibility Curves
- Resource Allocation
- Scope of Economics
- The Economic Problem
- Trade Offs in Economics
- Traditional Economies
- Utility Theory
- Factor Demand Curve
- Factor Demand and Factor Supply
- Land Market
- Market Distribution of Income
- Market for Capital
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- Contestable markets
- Cournot Model
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- Game Theory
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- Monopolistic Market
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- Monopoly Power
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- Monopoly Profit Maximization
- Nash Equilibrium
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- Objectives of Firms
- Oligopolistic Market
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- Price Discrimination
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- Prisoner's Dilemma
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- Tacit Collusion
- The Kinked Demand Curve
- Demand for Labour
- Discrimination in the Labour Market
- Elasticity of Demand for Labour
- Equilibrium Wage
- Equilibrium in Labour Market
- Imperfectly Competitive Labour Market
- Labor Movement
- Labor Supply Curve
- Labor Unions in the US
- Marginal Product of Labor
- Marginal Productivity Theory
- Marginal Revenue Product of Labor
- Perfectly Competitive Labour Market
- Supply for Labour
- The National Minimum Wage
- Trade Unions
- Trade Unions and Wages
- Wage Determination
- Antitrust Law
- Coase Theorem
- Common Resources
- Competition Policy
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- Consumer Surplus
- Consumer Surplus Formula
- Correcting Externalities
- Deregulation of Markets
- Economics of Pollution
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- Welfare in Economics
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- Price Discrimination: Airline Tickets
- Royal Mail Privatisation
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- Trade Unions in the UK
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- What Determines Oil Prices?
- Constant Cost Industry
- Demand Curve in Perfect Competition
- Increasing Cost Industry
- Long Run Competitive Equilibrium
- Long Run Supply Curve
- Perfect Competition Graphs
- Perfectly Competitive Firm
- Perfectly Competitive Market
- Short Run Supply Curve
- Arrow's Impossibility Theorem
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- Median Voter Theorem
- Anti Poverty Programs
- Distribution of Income
- Distribution of Wealth
- Economic Inequality
- Economic Mobility
- Equitable Distributions of Income
- Gini Coefficient
- Government Policies on Poverty
- In-Kind Transfers
- Income Inequality
- Income Redistribution
- Lorenz Curve
- Minimum Wage Laws
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- Poverty Line
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- Social Welfare Policy
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- The problem of Poverty
- Average Cost
- Constant Returns to Scale
- Cost Accounting
- Cost Curves
- Cost Minimization
- Costs of Production
- Decreasing Returns to Scale
- Diseconomies of Scale
- Economic Cost
- Economic Profit vs Accounting Profit
- Economies of Scale
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- Fixed Costs
- Increasing Returns to Scale
- Isocost Line
- Long Run Entry and Exit Decisions
- Long Run Production Cost
- Marginal Average and Total Revenue
- Marginal Cost
- Opportunity Cost of Capital
- Production Function
- Profit Maximization
- Returns to Scale
- Revenue vs Profit
- Short Run Production Cost
- Short Run Production Decision
- Specialisation and Division of Labour
- Technological Change
- The Law of Diminishing Returns
- Total Cost Curve
- Types of Profit
- Agricultural Price Supports
- Change In Supply
- Change in Demand
- Changes in Equilibrium
- Consumer and Producer Surplus
- Cost Revenue and Profit Maximization
- Cross Elasticity of Demand
- Cross Price Elasticity of Demand Formula
- Demand Curve
- Determinants of Demand
- Determinants of Price Elasticity of Demand
- Determinants of Supply
- Effects of Subsidies
- Effects of Taxes
- Elasticity of Demand
- Elasticity of Supply
- Income Elasticity of Demand
- Income Elasticity of Demand Formula
- International Trade and Public Policy
- Market Demand
- Market Disequilibrium
- Market Equilibrium
- Market Equilibrium Consumer and Producer Surplus
- Midpoint Method
- Price Ceiling Effects
- Price Ceilings
- Price Control
- Price Determination in a Competitive Market
- Price Elasticity of Demand
- Price Elasticity of Demand Formula
- Price Floors
- Price Signal
- Price elasticity of supply
- Quantity controls
- Shifts in Demand
- Shifts in Supply
- Tariffs and Quotas
- Taxes and Subsidies
- The Theory of Production
- Total Expenditure Test
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Thinking of trying out a new recipe? What is essential for you to get started on this recipe? Ingredients! Similar to how you need ingredients to cook or try out a recipe, the goods and services that we consume or that are produced by the economy also need ingredients. In economics, these ingredients are referred to as factors of production. All economic output is produced as a result of the combination of different factors of production, which makes them a crucial part of any business and economy at large. Keep reading to learn more about factors of production in economics, the definition, and more !
Factors of Production Definition
What is the definition of factors of production? Let's start from the view of the whole economy. An economy's GDP is the level of output an economy produces in a given period. Output production is dependent on the available factors of production . Factors of production are economic resources used to create goods and services.
Factors of production are economic resources used to create goods and services.
Karl Max, Adam Smith, and David Ricardo, pioneers of various economic theories and concepts, were the masterminds behind the idea of factors of production. In addition, the type of economic system may be the deciding factor on how the factors of the production are owned and distributed.
Economic systems are the methods that society and the government use as a means to distribute and allocate resources and goods, and services.
Factors of production in a communist economic system are owned by the government and are valued for their usefulness to the government. In a socialist economic system, the factors of production are owned by everyone and valued for their usefulness to all the members of the economy. Whereas in a capitalist economic system, the factors of production are owned by individuals in the economy and are valued for the profit that the factors of production generate. In the last type of economic system, which is known as the mixed system, the factors of production are owned by both individuals and everyone else and are valued for their utility and profit.
Check out our article - Economic Systems to find out more!
The use of the factors of production is to provide utility to the members of the economy. Utility, which is the value or satisfaction received from the consumption of goods and services, is part of the economic problem - the unlimited needs and wants of the members of an economy against the limited factors of production available to satisfy those needs and wants.
Factors of production being economic resources are innately scarce. In other words, they are limited in supply. Due to them being scarce in nature, their use in effective and efficient measures in production is important to all economies. It is important to note that despite being scarce, some factors of production will be cheaper than others, depending on the level of scarcity. In addition, the characteristic of scarcity also indicates that the goods and services produced will be sold for a higher price given if the cost of the factors of production is high.
Utility is the value or satisfaction received from the consumption of goods and services.
The fundamental economic problem is resource scarcity paired with the unlimited needs and wants of individuals.
Furthermore, factors of production are used in combination to produce the desired good or service. All goods and services in any given economy have the factors of production employed. Thus, factors of production are considered the building blocks of an economy.
Factors of Production in Economics
There are four different types of factors of production in economics: land and natural resources, human capital, physical capital, and entrepreneurship. Figure 1 below summarizes all the four types of factors of production.
Factors of Production Examples
Let's go through each of the factors of production and their examples!
Land & Natural Resources
The land is the foundation of many economic activities, and as a factor of production, land can be in the form of commercial real estate or agricultural property. The other valuable benefit that is extracted from land is natural resources. Natural resources such as oil, minerals, precious metals, and water are resources that are factors of production and fall under the category of land.
Company X wants to build a new factory for its operations. The first factor of production they need to start their business is land. Company X works towards acquiring land by contacting business realtors and viewing listings for commercial property.
Physical capital is resources that are manufactured and are man-made and used in the production of goods and services. Some examples of capital include tools, equipment, and machinery.
Company X has acquired the required land to build its factory. The next step is for the company to purchase physical capital such as machines and equipment needed to manufacture its goods. Company X looks for distributors that will have the best quality machines and equipment, as the company does not want to compromise on the quality of its goods.
Human capital which is also known as labor, is an accumulation of education, training, skills, and intellect that are used in combination to produce goods and services. It also refers to the general availability of the workforce.
Now that company X has both land and physical capital, they're eager to kick-start production. However, to start production, they need human capital or labor to produce the company's goods alongside managing the factory's business operations. The company has put out job listings for production and factory workers' roles, alongside listings for production supervisors and managers. The company will be providing competitive pay and benefits to attract the desired talent and number of workers needed for production.
Entrepreneurship is the ideas, the ability to take the risk, and the combination of the other factors of production to produce goods and services.
Company X has been successfully able to start production after recruiting skilled workers to operate their machines and equipment, alongside operational management staff as well. The company is eager to grow its business and is working on developing strategies to increase revenue through innovative ideas.
Factors of Production and their Rewards
Now that we know what the factors of production are let's see how they function in our economy and what are the resulting rewards of each of the factors of production.
A big food chain called Crunchy Kickin Chicken which is really popular in Europe, wants to expand into North America and open its franchise in the U.S. The chain has obtained a license to operate in the U.S. and has also acquired land to build its first branch. The rent that the chain will pay to the land resource owner is the reward for the acquisition or use of this factor of production.
Rent in economics is the price paid for the usage of land.
In addition, the machinery, equipment, and tools that the chain will be using for its business operations were acquired by paying the resource owner interest, which is the reward for this factor of production.
Interest in economics is the price paid or payment received for the purchase/sale of physical capital.
Now that Crunchy Kickin Chicken is ready to operate and has hired restaurant workers, it will pay wages that the workers will earn as their reward for the labor resource that they provide as a factor of production.
Wages in economics are the price paid or payment received for labor.
The chain has resulted in great success, the CEO of Crunchy Kickin Chicken will be earning a profit for his entrepreneurship as a reward for this factor of production.
Profit in economics is referred to as the income generated from employing all the other factors of production to produce output.
Factors of Production Labor
Oftentimes, labor, also known as human capital, is referred to as one of the main factors of production. That is because labor can impact economic growth - the increase in real GDP per capita resulting from the increase in sustained productivity over time.
Knowledgeable and skilled laborers can increase economic productivity, which in turn leads to economic growth. In addition, consumption expenditure and business investments impact labor, which also leads to an increase in economic growth. As the wages or disposable income increases, consumption expenditure of goods and services also increases, which not only increases GDP, but also increases the demand for labor.
All these series of increases impact economic growth. Moreover, as consumption expenditure increases, businesses are more profitable and tend to invest more back into the company through more capital and labor investment. Where capital investments can lead to more efficiency and productivity, an increase in labor allows the company to meet their increasing consumption demand resulting from the increased consumption expenditure.
Economies are created for the need for human civilization to not only survive but thrive, and one of the means through which the members of the economy thrive is through employment. Employment is one of the greatest sources of income for members of an economy. Members of the economy earn an income through supplying their labor and, in turn, receive wages as their reward. These wages are then used by the same member to purchase goods and services, which then further stimulates demand within the economy. As you can see, labor is very significant to an economy because it stimulates demand, which in turn stimulates output and, by extension, economic growth.
In economies where there is a shortage of labor as a factor of production, the resulting outcome is stagnation or negative growth in the GDP. For example, in the recent pandemic, many businesses and companies faced temporary closures as their workers contracted the virus. The series of closures resulted in a delay in every step of the production process, such as the delivery of material, production line, and delivery of final goods. The delay resulted in less output being produced in the overall economy, which led to negative growth in many economies.
Factors of Production - Key takeaways
- The utility is the value or satisfaction received from the consumption of goods and services.
- The four factors of production are land, physical capital, human capital , and entrepreneurship.
- The reward for land is rent, for capital is interest, for labor or human capital is wages, and for entrepreneurship is profit.
- Human capital or labor is known as one of the main factors of production as it impacts economic growth.
Frequently Asked Questions about Factors of Production
--> what are the factors of production in economics.
Factors of production are economic resources used to create goods and services. The four factors of production are: land, physical capital, human capital and entrepreneurship.
--> Why is labor the most important factor of production?
That is because labor can impact economic growth - the increase in real GDP per capita, resulting from the increase in sustained productivity over time.
--> How does land affect factors of production?
Land is the foundation of many economic activities. A valuable benefit that is extracted from land is natural resources. Natural resources such as oil, minerals, precious metals, and water are resources that are factors of production and fall under the category of land.
--> What are examples of factors of production?
Some examples of factors of production are: oil, minerals, precious metals, water, machinery and equipment.
--> Why are the 4 factors of production important?
Because an economy's GDP is the level of output an economy produces in a given period. Output production is dependent on the available factors of production.
Final Factors of Production Quiz
How would you define factors of production?
The use of the factors of production is to provide -------------------- to the members of the economy
What is the economic problem?
The unlimited needs and wants of the members of an economy against the limited resources available to satisfy those needs and wants.
What are the four factors of production in economics?
land and natural resources, physical capital, human capital and entrepreneurship
Land can be in the form of commercial real estate or agricultural property. The other valuable benefit that is extracted from land is natural resources.
Physical Capital are resources that are ---------------------------- and are ------------- - ---------- and used in the production of goods and services.
Examples of physical capital include:
tools, equipment, and machinery
Human capital which is also known as labor is an accumulation of machinery, equipment and tools that are used in combination to produce goods and services.
How would you define entrepreneurship?
Entrepreneurship is the ideas, the ability to take the risk and the combination of the other factors of production to produce goods and services.
The reward for land as a factor of production is:
The reward for physical capital as a factor of production is:
The reward for human capital or labor as a factor of production is:
The reward for entrepreneurship as a factor of production is:
Why is human capital or labor considered one of the main factors of production?
The reason for that is that labor can impact economic growth .
Capital investments can lead to more efficiency and productivity, an increase in labor allows the company to meet their increasing consumption demand resulting from the increased consumption expenditure.
- Market Efficiency
- Production Cost
- Political Economy
- Factor Markets
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