Factors of Production

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.

Fig. 1 - 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.

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.

Fig. 2 - Entrepreneurship is a factor of production

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.

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.

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.

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.

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 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.

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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.