Factors of Production
What is Factors of Production?
Factors of production are the resources used in the production of goods and services, including land, labor, capital, and entrepreneurship.
Land refers to natural resources, labor is the human effort, capital includes man-made resources like machinery and equipment, and entrepreneurship is the risk-taking and organizational ability of business owners. These inputs are combined in various ways to produce outputs. The quantity and quality of a country's factors of production determine its productive capacity.
Factors of Production: a worked example
A coffee shop uses all four factors at once: the lot it sits on and the water it draws are land, the baristas' hours are labor, the espresso machine and ovens are capital, and the owner who put up her savings and chose the location supplies entrepreneurship. Each factor takes its own payment out of revenue. On $400,000 of annual sales the shop pays $30,000 rent for land, $250,000 in wages for labor, $20,000 interest on the equipment loan for capital and $60,000 for beans and milk bought from other firms, leaving $40,000 of profit as the return to entrepreneurship. The beans and milk are intermediate goods rather than one of the shop's own four factors, because another firm already used land, labor and capital to produce them.
The mistake students make with factors of production
Students count money as capital, so they call a $50,000 bank balance one of the firm's factors of production. Money produces nothing by itself; capital in economics means produced goods used to make other goods, such as machines, tools, trucks and factory buildings. The $50,000 is financial capital, and it becomes a factor of production only once it is spent on physical capital.
Factors of Production questions
What are the four factors of production and what does each one earn?
The four factors of production are land, labor, capital and entrepreneurship, and they earn rent, wages, interest and profit respectively. Together these four payments account for all the income generated by producing output.
Is money a factor of production?
Money is not a factor of production, because it does not produce anything on its own; it is a medium of exchange used to buy the factors that do. Economists reserve the word capital for physical items like machinery and equipment, and call funds financial capital.
Why is entrepreneurship treated as a separate factor from labor?
Entrepreneurship is separate from labor because it is the function of organizing the other three factors and bearing the risk of loss, rather than supplying effort under a contract. That is why it is paid in profit, which is whatever remains after rent, wages and interest, and can be negative.
Related terms
Common comparisons
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free, no spam.
No spam. Unsubscribe anytime. Read our privacy policy.
Keep track of what you have studied
A free EconLearn account adds progress tracking, your quiz history, and achievements. Studying here is free either way, and there is nothing to pay for as a student.
Create a free accountAlready have one? Sign in
Last updated