What’s it: As a factor of production, labor refers to the workers’ efforts (physical and mental) used in the production process. It connotes what the individual contributes (services), not refer to the individual himself (workers). So, labor can also be interpreted as all human resources available for use in the production process. In a broader definition, it refers to human capital.
We need labor along with other factors such as capital, land, and entrepreneurship. All four must be present for the business to run. Entrepreneurs, who supply entrepreneurship, combine and organize the other three resources to start a business. Then, they take risks by commercializing the business idea, hoping to make a profit.
Businesses use the workforce to perform tasks and jobs across various operations. For example, they may hire workers to operate machinery, manage finances, drive vehicles, or do administrative work.
The reward for labor is wages. It covers wages, salaries, or other compensation such as health benefits and insurance.
Labor as a factor of production in economics
Economists divide economic resources (also known as factors of production) into four types:
The first two are non-human resources. Land represents available natural resources. Meanwhile, capital is a man-made tool. Both are inputs for producing goods and services.
Then, the last two are human resources. Human resources mean labor and entrepreneurship contributed by individuals. Both are inputs to production, only different roles – and therefore, receive different compensation.
Labor refers to the physical and mental work performed by individuals to produce goods or services. It represents what the worker contributes. They work under other people (entrepreneurs) and don’t risk putting the other three factors together. As compensation, they get wages.
In contrast, entrepreneurship refers to an individual’s attempt to take risks to run a business. It represents what the entrepreneur is supplying. And, as compensation, entrepreneurs expect to make a profit – although sometimes, they also have to bear losses due to business failure.
Entrepreneurs commercialize business ideas and start businesses. They combine capital and natural resources as inputs to produce goods or services. They also recruit workers.
Often entrepreneurs are seen as innovators. They develop new ways to produce and new products. They developed various new products, which were not even imagined by people as computers and mobile phones at the first of their release.
Labor quantity and quality
The labor quantity is important to increase production. By hiring more workers, businesses can generate more output.
Another important aspect is quality. Quality improvements make workers more productive, enabling them to produce more output. Quality can be improved through training, education, and experience.
Another factor is technology. It can increase productivity by increasing access to skills or knowledge. For example, we can learn about various ways to deal with everyday problems through the internet. Moreover, it’s easier and cheaper than having to visit a specialist or a training center.
Technology also makes us more productive through the capital goods we use. For example, a business can quickly produce output at a higher scale using more technologically advanced machines.
For this reason, in the production function, technology is usually considered an exogenous factor for production and economic growth. It impacts various industries and stimulates the productivity of labor and capital.
There are different types of labor, including:
- Skilled workers – have expertise in a particular field through education, training, and work experience. Examples are mechanics, pharmacists, and writers. Sometimes they are further broken down into skilled and educated workers, with the latter having expertise or proficiency in a particular field through schooling or education.
- Unskilled workers – rely more on physical effort. Their jobs often do not require higher education or training. Examples are porters and haulers.
- Freelance – not committed to an employer for a certain period and self-employed. According to their personal preferences, they are free to decide what projects they take on, when to do them, and where to do them.
- Contract workers – perform tasks and work under a contract, which specifies the type of work, duration, and compensation received. Workers usually do not receive benefits. When the contract is completed, they are unemployed unless they submit a contract extension for another project or find work elsewhere.
- Permanent worker – bound by an employment contract to work in the company. They receive a salary, usually monthly, and some benefits as agreed in the contract. Leave, or abstention usually does not reduce their salary because it does not depend on working hours.
- Full-time workers – work in a bonded manner with normal working hours, for example, 8 hours a day or 30-40 hours a week. They are usually permanent workers and receive a monthly salary which is independent of working hours.
- Part-time workers – work for less than normal working hours. They may take several jobs during one day to maximize income.
- Temporary workers – work for a certain period or for a specific task or project, after which they no longer work unless they get another job.
- Seasonal workers – work only during certain seasons, for example, tourism workers. After that, they are unemployed or looking for other non-seasonal work.
The demand for labor is determined by:
- Business activity
- Wage rate
When business activity increases, they need more workers to produce more goods and services. On the other hand, the labor demand decreases when business activity is sluggish.
- Take, for example, seasonal workers in the tourism sector. The demand for labor increases during the peak season and falls during the normal season. And during normal seasons, employers may retain only core employees.
- The demand for labor and business activity also depends on the economic cycle. During the expansion phase, the demand for goods and services increases, prompting businesses to increase production and recruit more workers. In contrast, during a recession, business activity and demand for labor fall due to sluggish demand.
Furthermore, the demand for labor is inversely related to the wage level. Therefore, when wage rates rise, businesses are less willing to hire more labor because it is expensive, increasing their production costs.
- Conversely, low wages encourage businesses to ask for more labor. They can increase production by adding more workers.
In addition to these two factors, the demand for labor is also influenced by skills, education, available technology, and the nature of production (capital-intensive or labor-intensive).
In the economy, the total supply of labor is represented by the labor force. The labor force includes the working-age population (15-64 years) who are currently working, plus unemployed but are actively looking for work. It excludes various people such as:
- Stay-at-home mom.
- Those who take care of the family and are not actively looking for work.
- Those who are studying.
- Discouraged workers who have given up looking for work.
Various factors affect the supply of labor, including:
- Wage rate – the dollar amount received by workers, usually expressed as per hour worked in economics.
- Population growth – the increase in the number of people in a country.
- Birth rate – the number of individuals born in a given time, usually expressed per year per 1,000 population.
- Death rate – – the number of individuals who died in a given time, usually expressed per year per 1,000 population.
- Labor force participation rate – total labor force divided by the working-age population.
- Emigration – those who move abroad and live permanently there.
- Immigration – foreigners who move into the country and stay permanently.
Labor supply is positively related to wage levels. When the wage rate rises, people like to supply their labor for more dollars. Conversely, when the wage rate falls, people supply less labor and prefer to enjoy their free time.
But, at a certain wage level, the increase does not encourage people to supply more labor. Instead, they are less willing to supply labor. It then forms a backward bending supply curve of labor.