Factors of Production

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. In economics, there are four factors of production: land, labor, capital and entrepreneurship.

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.

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.

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.

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.

Physical Capital

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.

Human Capital

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.

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.

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 increases 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.

https://studysmarter.atlassian.net/wiki/spaces/CD/pages/34964367/Sourcing+uploading+and+archiving+images

Fig. 3 - Labor increases economic growth

All these series of increases impact economic growth. Moreover, as consumption expenditure increases, businesses are more profitable and tend to invest more into the company through 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. The same member then uses these wages to purchase goods and services, further stimulating 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.