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Factors of production

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In economics, factors of production are resources used in the production of goods and services.

Land, labor, and capital Edit

Resource categories in economics distinguish among such factors of production as:

  • Land or natural resource – naturally-occurring goods such as soil and minerals that are used in the creation of products. The payment for land is rent.
  • Labor – human effort used in production which also includes technical and marketing expertise. The payment for labor is a wage.
  • Capital goods – human-made goods (or means of production) which are used in the production of other goods. These include machinery, tools and buildings. In a general sense, the payment for capital may take the form of interest or dividends.

Development in classical economicsEdit

The distinction above was developed in classical economics, including the work of Adam Smith, 1776, David Ricardo, 1817, and the later contributions of Karl Marx and John Stuart Mill as part of one of the first coherent theories of production and distribution in political economy. Marx refers in Das Kapital to the three factors of production as the "holy trinity" of political economy. Working capital was generally viewed as being a stock of physical items such as tools, buildings and machinery. This view was explicitly rejected by Marx. Classical economics developed the labor theory of value as part of the theory of distribution.

Development in neoclassical economics and a modern controversyEdit

Neoclassical economics continued the distinction of land, labor, and capital. It developed an alternative theory of value and distribution. For a modern discussion about problems in defining and theorizing about the neoclassical theory of capital, see capital controversy.

Free trade and movement of factors of productionEdit

Free trade laissez faire theory argues that economic efficiency is achieved in cases where free movement (laissez passer) of the "factors of production" is permitted. Karl Polanyi in "The Great Transformation", however, argued that historically whenever laissez faire policies are adopted, legal moves to prevent the free movement of one of the factors of production always occur (for example current neo-liberal attempts to free the movement of capital and resources are today increasingly tied to immigration controls).

Human capital and intellectual capital Edit

Contemporary analysis distinguishes capital goods from other forms of capital such as human capital. Human capital is acquired through education and training, whether formal or on-the-job. A more recent coinage is intellectual capital, used especially as to information technology.

Prior to the Information Age the land, labour, and capital were used to create substantial wealth due to their scarcity. During the Information Age (circa 1971-1991), the Knowledge Age (circa 1991 to 2002), and the Intangible Economy (2002-present) the primary factors of production have become less concrete. These factors of production are knowledge, collaboration, process-engagement, and time quality. According to economic theory, a "factor of production" is used to create value and economic performance. As the four modern-day factors are all essentially abstract, the current economic age has been called the Intangible Economy. Intangible factors of production are subject to network effects and the contrary economic laws such as the law of increasing returns. It is therefore important to differentiate between conventional (tangible) economics and intangible economics when discussing issues related to factors of production which change according to the economic era that society is experiencing. For example, land was a key factor of production in the Agricultural Age.

Combination of factors Edit

Some economists mention enterprise, entrepreneurship, individual capital or just "leadership" as a fourth factor. However, this seems to be a form of labor or "human capital." When differentiated, the payment for this factor of production is called profit. This is when entrepreneurs think of ideas, organise the other three factors of production, and take risks with their own money and the financial capital of others.

In a market economy, entrepreneurs combine the factors of production,land, labor, and capital in an innovative way to make a profit. In a planned economy, central planners decide how land, labor, and capital should be used to provide for maximum benefit for all citizens.

Further distinctions from classical and neoclassical microeconomics include the following:

  • Entrepreneurs are people who organize other productive resources to make goods and services. The economists regard entrepreneurs as a specialist form of labor input. The success and/or failure of a business often depends on the quality of entrepreneurship.
  • Capital has many meanings including the finance raised to operate a business. Normally though, capital means investment in goods that can produce other goods in the future. It can also be referred to as machines, roads, factories, schools, and office buildings in which humans produced in order to produce other goods and services. Investment is important if the economy is to achieve economic growth in the future.
  • Fixed Capital this includes machinery, work plants, equipment, new technology, factories, buildings, and goods that are designed to increase the productive potential of the economy for future years.
  • Working Capital this includes the stocks of finished and semi-finished goods that will be economically consumed in the near future or will be made into a finished consumer good in the near future. It includes also the liquid assets needed for immediate expenses linked to the production process (salaries, invoices, taxes, interests...).

See alsoEdit

Management-related material:

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