Factor income represents income streams to suppliers of production factors (land, capital, labor, and entrepreneurship). Their compensation consisted of profits, rent, and wages. I will briefly review all four.
What are the components of income factor?
Economists divide the factors of production, also known as economic resources, into four groups. They are:
- Capital
- Labor
- Land
- Entrepreneurship
Interest for capital
Capital includes man-made equipment for making goods and providing services. Examples are computer machines and equipment. Capital suppliers receive interest as compensation.
Wages for labor
Labor represents the efforts, knowledge, and skills of individuals in the production process. Sometimes, we call it human resources. Workers receive wages as compensation for their services.
Rent for land
Land includes natural resources such as minerals, sea, arable land, and the environment. They may be renewable and non-renewable resources. This factor supplier accepts rent as compensation.
Profit for entrepreneurs
Entrepreneurs are individuals who take business risks to meet the needs of consumers. They combine three other factors of production to produce goods or services. As compensation, they make a profit (dividends and retained earnings).
Why is the income factor important?
In macroeconomics, we use this term to determine the difference between gross domestic product (GDP) and gross national product (GNP).
GDP measures the total market value of goods and services produced by factors of production (for example, labor, capital, etc.) within the country, regardless of whether they are owned by citizens or foreigners.
Whereas, the GNP measures the market value of all final goods and services produced by the factors of production provided by citizens, regardless of whether production takes place inside or outside the country. GNP includes goods and services produced by citizens abroad. But, it excludes goods and services provided by foreigners in the country.
For example, income from capital owned by foreigners invested in Indonesia is included in Indonesia’s GDP but not its GNP. The income of Indonesian citizens working abroad is included in the Indonesian GNP but not in Indonesia’s GDP.
The difference between GNP and GDP is usually small because the income generated by citizens abroad and by foreigners at home often compensates for each other. Significant differences in income factors are more likely to be found in small developing countries, where most of the income can be generated by foreign direct investment (FDI).
Analysts prefer to use GDP rather than GNP. They consider GDP more comprehensive. It measures the value of goods and services produced domestically and therefore has an impact on economic growth, employment, and the investment environment in the domestic economy.
