Factors of production are inputs used to produce an output. They are resources a company requires to attempt to generate a profit by producing goods and services. Factors of production are divided into four categories: land, labor, capital, and entrepreneurship.
These inputs have varying levels of importance to the production process depending on the industry and type of business using them. They are regarded in different ways by different schools of economic thought.
- Factors of production are resources a company uses to generate a profit by producing goods and services.
- Land, labor, capital, and entrepreneurship are the four categories of factors of production.
- Different schools of economic thought have different views on the ideal way to control and use the factors of production.
- The primary difference between capitalism and socialism is about the ownership of the primary factors of production.
The Four Factors of Production
There are four factors of production, or inputs needed to create goods and services:
Land is not just restricted to the physical property or real estate. It includes any natural resources the land produces, such as crude oil, coal, water, gold, or natural gas. The resources are natural materials that are included in the production of goods and services.
Labor is the amount of work done by workers or employees that contributes to the production process. This can be physical labor, such as that done by farm employees, or non-physical labor, such as the hours worked by a software engineer.
Capital (also known as capital goods) is any tool, building, or machine used to produce goods or services. Capital varies throughout each industry. For example, a computer scientist uses a computer to create a program; their capital is the computer they use. On the other hand, a chef uses pots and pans to deliver a good and service, so the pots and pans are the chef’s capital.
Entrepreneurship, sometimes called intellectual capital or risk-taking, combines these factors of production to earn a profit. For example, an entrepreneur brings together gold, labor, and machinery to produce jewelry. The entrepreneur takes on all the risks and rewards that come with producing a good or service.
Which factor of production is most important depends on the type of business. For a real estate business, land might be the most important input. But for a housecleaning agency, labor would be the most important.
Capitalism vs. Socialism
Most economic schools identify the same four factors of production. Monetarist, neoclassical, and Keynesian schools of thought are mostly in agreement that businesses and investors should own the factors of production, which are then used to create economic growth. Marxist and neo-socialist schools argue that the factors of production should be nationalized and that growth primarily comes from labor capital.
The chief debate between capitalism and socialism is about the ownership of the primary factors of production. Capitalists believe that private ownership is a necessary condition for competition, innovation, and sustained economic growth. Socialists and Marxists argue that accumulated private capital leads to unchecked wealth disparity and the concentration of power in the hands of a few business interests.
Austrian School of Economic Thought
The Austrian school of economic thought is perhaps the most capital-intensive school, suggesting that the structure of the factors of production determines the business cycle.
Austrians argue that normal Keynesian and neoclassical models are fundamentally flawed because they aggregate all production capital into senseless snapshots. For example, the standard notion of gross domestic product (GDP) treats all investments as equal and treats all capital goods sales as equal.
Austrians contend the factors of production need to be viewed as heterogeneous and time-sensitive.
The Austrian method stresses that it makes a real difference whether producers build houses or lay down railroad tracks. For example, if a ton of steel is used towards a sustainable end, it should be treated as more valuable than when it is wasted during a housing bubble.
Mistakes made with capital goods are more difficult to correct and lead to more serious long-term consequences. This is referred to as the heterogeneity of capital. Since capital goods investment and usage are closely tied to the interest rate, Austrians oppose even nominal interest rate controls by central banks.
Who Is In Charge of the Factors of Production?
Control of the factors of production varies depending on a country’s economic system. In capitalist countries, these inputs are controlled and used by private businesses and investors. In a socialist country, however, they are controlled by the government or by a community collective. However, few countries have a purely capitalist or purely socialist system. For example, even in a capitalist country, the government may regulate how businesses can access or use factors of production.
Is Money One of the Factors of Production?
Money is not one of the factors of production. Money facilitates trade and can be used to measure the value of a good or service. But the goal of economic activity is to acquire goods, rather than money. Money is used to afford goods and services, but it cannot create them.
What Is Another Name for Capital In the Factors of Production?
Capital is one of the four factors of production. It is also known as capital goods or the means of production. Capital in this sense does not refer to money.
The Bottom Line
The four factors of production are land, labor, capital, and entrepreneurship. These are the inputs needed to create goods and services, which then lead to economic growth.
There are different schools of economic thought, and these take different views of how the factors of production should be owned and used. For example, the primary difference between capitalist and socialist economic views comes from how they regard the factors of production. Capitalists believe they should be controlled by private businesses and investors, while socialists believe they should be centrally owned by the government or community.