What’s it: Factors of production are inputs for producing goods and providing services. They consist of land, labor, capital, and entrepreneurship. The last one, entrepreneurship, combines the other three factors of production. Also called resources or inputs.
The quantity and quality of resources determine economic growth. When they are more abundantly available and of better quality, it allows the economy to produce more goods and services.
What are the types of factors of production?
Economists divide the production factors into four categories:
Land is not only the site for agriculture or office buildings but also includes natural resources, which we use to produce goods and services. Examples are wood, oil, coal, gas, metals, and other mineral resources.
Natural resources consist of two groups, renewable and non-renewable resources.
- Renewable resources are available in unlimited quantities because nature is always multiplying them. Examples are air and sunlight. Water is another example, which we can use to generate electricity and for consumption.
- Non-renewable resources will run out if we use them irresponsibly. They include oil, natural gas, coal, metals, and other minerals.
Some countries, such as Indonesia and China, are rich in natural resources. They then specialize in their extraction and production, including developing their downstream industry.
Other countries such as South Korea and Japan have inadequate natural resources. Therefore, they are highly dependent on imports from other countries. To promote economic growth, they specialize not in natural resources but in capital, labor, and entrepreneurship.
Businesses use natural resources as inputs in the production process. For example, they use the mineral bauxite to produce aluminum, ultimately sold to various industries such as automobiles and airplanes.
Labor includes individual effort, energy, skills, and knowledge used in the production process. Some jobs require more effort and physical exertion than knowledge or skill. While others rely more on skill and knowledge than effort.
As with natural resources, the quantity and quality of resources determine how much output can be produced. For example, when hiring more employees, a business can produce goods or services. Likewise, when their quality improves, they are more productive and produce more output than before. In this case, education, experience, and training determine their quality.
In this context, capital refers to physical capital or man-made tools used by businesses to produce goods and services. In economics, it excludes financial capital (money). Examples are machinery, equipment, tools, factories, and other buildings.
Capital varies by business and type of work. For example, a doctor uses a stethoscope and examination room to provide medical services. Workers in factories use machines to produce food or cars. And, copywriters use computers to create content.
Entrepreneurship represents the willingness and ability to take risks in pooling and organizing other resources to produce goods and services. We refer to individuals who do this as entrepreneurs, who are business owners or founders.
To realize product ideas, entrepreneurs combine raw materials or inputs, employees, and capital. To get all three, they need financial capital, for example, from bank loans. Or they invest their own money.
To be successful, they need skills such as innovative thinking as well as organizational, management, and leadership skills.
The most successful entrepreneurs are innovators. They find new ways to produce goods and services. Think of people like Bill Gates, Steve Jobs, Larry Page, and Sergey Brin. Without their entrepreneurship, you will not benefit from computers, Apple, or surfing online.
Why is money not a factor of production?
Economists distinguish financial capital (money) from physical capital. They do not categorize financial capital as a resource for producing goods and services.
This is because businesses cannot use money directly to produce goods or services. For example, they can’t make canned food out of money. Likewise, they can’t make laptops with money. So, in this case, money is not a productive resource.
We can indeed use it to buy physical capital such as machines or computers. However, the contribution is not direct. Have you ever seen a copywriter write content using money? Money only facilitates trade. With money, the copywriter can buy a computer on which he can write content.
Why are resources scarce?
Resources are scarce. It is available in limited quantities to satisfy our unlimited needs and wants.
Consider clothes. The clothes are made of cotton, which is planted in the ground. In cotton-producing countries, not all land is used to grow cotton. Some land is used to grow other products such as soybeans or rice, which we also need.
Another example is workers in a clothing factory. Those who work to cut and sew clothes in factories are also limited. Not everyone works in a clothing factory. Other people need to work in other factories to produce other goods or services we need.
Scarcity then forces us to make choices. For example, what products do we need to produce?
Cost of using factors of production
When we use factors of production, we incur costs. For resource suppliers, it becomes their income, sometimes also referred to as the reward they receive. Here are the rewards for the factors of production:
- Rent as compensation for land
- Wages for the use of labor
- Interest for capital use
- Profit for entrepreneurship
If we add up the four, that is factor income, which in aggregate is national income.
Why are resources important to the economy?
Economic growth not only depends on the quantity of production factors but also their quality. Both determine the productive capacity of the economy, i.e., how much goods and services can be produced, both in the short and long run.
Why is quality important? Let’s take labor as the first case. When there is more labor (quantity), the business can produce more output. For example, one person produces 10 units. If the company recruits 10 new workers, then the company gets an additional 100 units of output.
Then, even with the same number of workers, the company can still produce more output. Companies can increase their productivity (quality), for example, through training. Thus, say, after training, a worker can produce 11 units of output.
The second case is capital. Having more machines means higher business production capacity. Likewise, with more sophisticated machines (quality), the company can produce more output from the same amount of input. For example, using a computer can generate more articles than using a typewriter.
Quality is why resource-poor countries such as South Korea and Japan can grow into developed countries. They invest in the productivity of labor and capital to be able to produce more. They also encourage entrepreneurship.
Entrepreneurs are a vital engine of economic growth, giving rise to some of the world’s major companies, such as Samsung Electronics, Hyundai Motor, and POSCO in South Korea; and Toyota Motor Corporation, SoftBank Group, Mitsubishi UFJ Financial Group, and Sony Corporation in Japan.