Factors of Production: The Four Inputs Behind Everything Made
Definition
Factors of production: the economic resources used to produce goods and services, classified by economists into land, labour, capital and enterprise.
- Every good or service is produced by combining four factors of production: land, labour, capital and enterprise.
- Each factor is scarce, so each earns a reward that becomes someone's income.
- How much an economy can produce depends on both the quantity and the quality of these factors.
Note
- The four factors are land, labour, capital and enterprise.
- Their rewards are rent, wages, interest and profit respectively.
The Four Factors and What They Earn
- Land, rewarded by rent
- All natural resources, such as fields, minerals, water and oil.
- The environment itself, clean air, fresh water and a stable climate, is part of land and is a scarce resource, so using it up in production carries an opportunity cost.
- Labour, rewarded by wages
- The human effort, both physical and mental, used in production.
- Capital, rewarded by interest
- Man-made aids to production such as machines, tools and factories, which is not the same as money.
- Enterprise, rewarded by profit
- The factor that organises the other three and bears the risk of production.
Example
- Take Greggs, the UK bakery chain, to see all four factors combined in a single firm.
- Land: the high-street shop sites and the flour and other ingredients, earning rent.
- Labour: the bakers, drivers and shop staff, earning wages.
- Capital: the ovens, refrigerated vans and tills, earning interest.
- Enterprise: the managers who combine the other three, choose the product range and bear the risk of unsold stock, earning profit.
Note
- Capital means physical aids to production, so money is not capital but a means of buying it.
- Economists also separate human capital, the skills and knowledge of workers, from physical capital.
Why the Quality of Factors Drives Growth
- Increasing the quantity of factors, such as a larger workforce, raises how much an economy can produce.
- Improving their quality, through education or better technology, raises output without needing more inputs.
- This is why investment in human and physical capital shifts an economy's production possibilities outward (1.1.5).
Which Factor Matters Most Depends on the Industry
- It depends on the industry: farming is land-intensive, a call centre is labour-intensive and a car plant is capital-intensive.
- Enterprise is often seen as decisive because it combines the others and takes the risks that create new output.
- In modern economies human capital is increasingly important, since skills determine how productively the other factors are used.
Exam technique
- Learn the four factor-and-reward pairs precisely, as examiners test them directly.
- When analysing a firm, identify which factors it uses most intensively.
- Link improvements in factor quality to higher productivity and growth.
Common Mistake
- Do not confuse capital with money.
- Capital is a man-made aid to production, whereas money is simply a means of buying those aids.
- Do not treat enterprise as just another word for labour.
- Enterprise organises the other factors and bears risk, which ordinary labour does not.
Self review
- Name the four factors of production.
- State the reward earned by each factor.
- Explain why money is not classed as capital.
- What is the difference between human and physical capital?
- Why is enterprise treated as a separate factor?
- Explain why the environment is regarded as a scarce resource.
