Factors of Production
Factors of production are resources that are involved in the production of goods and services. According to traditional economic theory, there are four main factors of production, such as land, labor, capital, and entrepreneurship. Those who own factors of production and have control over them are considered to be the richest people in the world. In a capitalist society, they are typically owned and controlled by entrepreneurs and investors. In socialist economies, the factors of production are dependent on the decisions made by the government.
Factors of Production explained
Different definitions are rooted in various economic approaches. Neoclassicists gave a clear definition: factors of production are land, labor, capital, entrepreneurship used for the production of goods and services, production factors. Neoclassicists usually substitute this concept for the concept of "productive forces".
Focusing on the factors of production, political economists first mentioned land, labor and capital in their early works. In today’s world, capital and labor are defined as the main resources that a business can use to generate a profit.
Overview of main factors
Economists divide the factors of production into four types —land, labor, capital, and entrepreneurship.
Land. Land as a factor of production includes all natural resources used in the manufacturing process, located in the bowels of the earth (minerals) and on its surface (water resources, forests, agricultural and non-agricultural lands, etc.). Such resources are also called natural resources. These are the factors that are not derived from human labor and are natural, but can be refined for human consumption.
In physiocratic school, economists recognized land as the only input and agriculture as the predominant sphere of development and investment.
Though land has a great impact on the productiveness of most businesses, the value of land may differ depending on the industries. For instance, an individual can start a tech company without investing in residential land. By contrast, land is the main input for businesses that invest in real property.
Labor. Labor as a factor of production is of a high importance as it refers to the participation of a person in the process of marketing the product, the use of his own energy, mental and physical abilities and potential. For example, top and middle managers participate in the labor force. Even people who work in the creative industries, such as acting, art and design, are a part of labor.
Early political economists and theorists originally identified labor as the main factor of production.
Investments in labor are extremely effective for society and economy in general and pay off quickly. Wages are compensation, which is given to an employee in the form of money in accordance with the quantity and quality of the labor provided. Firms usually pay lower wages to uneducated and inexperienced workers because these workers can be easily replaced. Qualifications, skills, labor productivity, level of education and other factors provide better opportunities for higher earnings. The term “human capital” describes knowledge, skills and health that people accumulate throughout their lives, which allow them to become useful and productive members of society. For instance, working as a physician requires extensive education and training.
Human capital is a fundamental determinant of a country's productivity.
The differences between wage rates often occur because of the fact that some employees lack particular skills and practical training, while others have better preparation for employment.
Capital. Capital as a factor of production refers to resources created by humans. They are used in the production of economic goods to generate a profit. The capital includes buildings, equipment, tools, technologies, innovations, materials, raw materials, semi-finished products. Nowadays, capital is usually associated with cash and other assets. Money allows business owners to organize production efficiently, pay employees in return for work, etc.
Neoclassical economics emphasizes capital as a key factor for economic production.
Capital can be divided into two types — private and personal. If an individual uses a vehicle for business purposes, for example, to transport goods, it is considered to be a capital.
During a downturn in economic activity, organizations strive to cut business expenses and spend less on the development of machinery, building, etc. Nevertheless, as the economy recovers, we can witness businesses with an increasing focus on upgraded physical assets.
Entrepreneurship. Entrepreneurship is the ability to organize and manage production in order for the company to achieve the best results. It is a binding component that rationally combines three other factors of production to bring goods into the market. For instance, the founder of the Hilton Hotels Conrad Hilton is an example of a successful entrepreneur.
In 1919, 31-year-old Conrad Hilton visited the small Texas town of Cisco. Previously, the young man was already engaged in business, but the bank he had set up was sold in a year. At that time, Conrad had about 5 thousand dollars left on his hands, and he decided to try again — search for a bank to buy or open a new one.
Hilton decided to stay in a local hotel for a certain period of time. When he came there, he was surprised that there were so many people who wanted to rent a room and almost no rooms available.
The owner of the Mobley Hotel was ready to sell his business at any moment as it was hard for him to run the hotel. Hilton made a deal within a few days. A few years later, the fashionable Dallas Hilton opened its doors, and today the famous chain of hotels and resorts is spread all over the world.
Combining the Factors of Production
Starbucks Corporation is another clear example of entrepreneurship. It is critical for a multinational chain of coffeehouses to encompass such factors of production, as land (stores in nearly every affluent neighborhood in the U.S.), capital (commercial coffee machinery), and labor (employees who make and serve coffee drinks, managers, etc.). The fourth input considered a binding component is presented by Howard Schultz, a leader who built Starbucks. He was the one who combined the inputs into a product and turned his business into the world's largest coffee empire.
Ownership of Factors of Production
It is presumed that households own the factors of production. The owner can independently dispose of the factors of production belonging to him and assign the results of production. However, he may transfer part of the rights to other entities. In this case, households may transfer the ownership right over the factor to a third party via sale. In practice, the ownership of these factors varies with the society, industry, and economic system.
For instance, owners of retail companies usually rent commercial property for the purpose of offering goods and services to customers.
This is also true for capital. Nevertheless, organizations can’t own labor — physical, mental, and social efforts of employees.