how factors of production work
the modern definition of factors of production is primarily derived from a neoclassical view of economics initially only labor was considered by most economists but eventually land and capital were considered as well entrepreneurship is a slightly more recent addition to the list as it was formerly lumped in with capital labor was the original factor of production identified by early economists such as adam smith and david ricardo in the early 20th century two swedish economists named bertil heckscher and eli ohlin were the first to expand the factors of production beyond labor production such as manufacturing can be tracked by certain indexes including the ism manufacturing index 1the 4 factors of productionthere are four factors of production land labor capital and entrepreneurship land as a factorland has a broad definition as a factor of production and can take on various forms from agricultural land to commercial real estate to the resources available from a particular piece of land natural resources such as oil and gold can be extracted and refined for human consumption from the land the cultivation of crops on land by farmers increases its value and utility for a group of early french economists called the physiocrats who predated the classical political economists land was responsible for generating economic value while land is an essential component of most ventures its importance can diminish or increase based on industry for example a technology company can easily begin operations in the founder s home with zero business investment in land on the other hand land is the most significant investment for a real estate venture labor as a factorlabor refers to the effort expended by an individual to bring a product or service to the market again it can take on various forms for example the construction worker at a hotel site is part of the labor as is the waiter who serves guests or the receptionist who enrolls them into the hotel within the software industry labor refers to the work done by project managers and developers in building the final product even an artist involved in making art whether it is a painting or a symphony is considered labor for the early political economists labor was the primary driver of economic value production workers are paid for their time and effort in wages that depend on their skill and training labor by an uneducated and untrained worker is typically paid at low prices skilled and trained workers are called human capital and are paid higher wages because they bring more than their physical capacity to the task for example an accountant s job requires the analysis of financial data for a company countries that are rich in human capital experience increased productivity and efficiency the difference in skill levels and terminology also helps companies and entrepreneurs create corresponding disparities in pay scales this can result in a transformation of factors of production for entire industries an example of this is the change in production processes in the information technology it industry after jobs were outsourced to countries with lower salaries capital as a factorin economics capital typically refers to money however money is not considered part of the capital factor of production because it is not directly involved in producing a good or service instead it facilitates the acquisition of things that are considered capital such as capital goods capital goods are items that allow a person or business to produce goods and services for example the machinery in a factory the computers of a tech company and the instrument of a musician are capital goods for modern mainstream neoclassical economists capital is the primary driver of value it is important to distinguish personal and private capital in factors of production a personal vehicle used to transport family is not considered a capital good but a commercial vehicle used expressly for official purposes is during an economic contraction or when they suffer losses companies cut back on capital expenditure to ensure profits however during periods of economic expansion they invest in new machinery and equipment to bring more products to market this investment further feeds economic growth an illustration of the above is the difference in markets for robots in china compared to the united states after the 2008 financial crisis after the crisis china experienced a multi year growth cycle and its manufacturers invested in robots to improve productivity at their facilities and meet growing market demands 23as a result the country became the biggest market for robots manufacturers within the united states which had been in the throes of an economic recession after the financial crisis cut back on their investments related to production due to tepid demand 45as a factor of production capital refers to the purchase of goods made with money in production for example a tractor purchased for farming is capital along the same lines desks and chairs used in an office are also capital entrepreneurship as a factorentrepreneurship is the secret sauce that combines all the other factors of production into a product or service for the consumer market an example of entrepreneurship is the evolution of the social media behemoth meta meta formerly facebook mark zuckerberg assumed the risk for the success or failure of his social media network when he began allocating time from his daily schedule toward that activity when he coded the minimum viable product himself zuckerberg s labor was the only factor of production after facebook became popular and spread across campuses zuckerberg realized he needed to recruit additional employees he hired two people an engineer dustin moskovitz and a spokesperson chris hughes who both allocated hours to the project meaning that their invested time became a factor of production the continued popularity of the product meant that zuckerberg also had to scale technology and operations he raised venture capital money to rent office space hire more employees and purchase additional server space for development at first there was no need for land however as business continued to grow meta built its own office space and data centers each of these requires significant real estate and capital investments connecting the factorsanother example of entrepreneurship is starbucks corporation sbux the retail coffee chain needs land prime real estate in big cities for its coffee chain capital large machinery to produce and dispense coffee and labor employees at its retail outposts for service entrepreneur howard schultz the company s founder provided the fourth factor of production by being the first person to realize that a market for such a chain existed and figuring out the connections among the other three factors of production 6while large companies make for excellent examples a majority of companies within the united states are small businesses started by entrepreneurs because entrepreneurs are vital for economic growth countries are creating the necessary framework and policies to make it easier for them to start companies 7ownership of factors of productionthe definition of factors of production in economic systems presumes that ownership lies with households who lend or lease them to entrepreneurs and organizations but that is a theoretical construct and rarely the case in practice except for labor ownership for factors of production varies based on industry and economic system for example a firm operating in the real estate industry typically owns significant parcels of land while retail corporations and shops lease land for extended periods of time capital also follows a similar model in that it can be owned or leased from another party under no circumstances however is labor owned by firms labor s transaction with firms is based on wages ownership of the factors of production also differs based on the economic system for example private enterprises and individuals own most of the factors of production in capitalism however collective good is the predominating principle in socialism at least in theory as such factors of production such as land and capital are owned partially or fully by the government under socialism and communism as we have seen in history the implementation has never matched the promises of the idealist theory with the factors of production usually being used for the benefit of those ruling the country rather than the common good in communist systems the role of technologywhile not directly listed as a factor technology plays a vital role in influencing production in this context technology has a fairly broad definition and can refer to software hardware or a combination of both used to streamline organizational or manufacturing processes increasingly technology is responsible for the difference in efficiency among firms to that end technology like money is a facilitator of the factors of production the introduction of technology into a labor or capital process makes it more efficient for example the use of robots in manufacturing has the potential to improve productivity and output similarly the use of kiosks in self serve restaurants can help firms cut back on their labor costs the solow residual also known as total factor productivity tfp measures the residual output that remains unaccounted for from the four factors of production and typically increases when technological processes or equipment are applied to production economists consider tfp to be the main factor driving economic growth for a country the greater a firm s or country s tfp the greater its growth 