In Economics, factors of production are those components used in the production process for the creation of finished goods and services.
The link between the quantity of individual inputs and the quantity of product obtained (output) is expressed by the production function.
The factors of production that are traditionally identified in economic theory are land, capital, labor, and entrepreneurship (or organization).
Historically, nature, labor, and capital have been identified as factors of production by economists such as Adam Smith, David Ricardo, and Karl Marx.
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This factor, also called “nature” or “natural capital”, includes goods not produced by man, and therefore arable land, building areas, the wealth of the subsoil, water resources, the sea, etc.
Within natural capital, with regard to its use as a factor of production, one can easily identify a characteristic that distinguishes two macro categories. This characteristic is sustainability, a characteristic closely connected to themes that, with the passing of time, have become more and more central in the public debate. While a very large portion of natural capital is made up of factors that cannot be reproduced, other natural assets, mainly through the progress of available technologies, are to be considered renewable, such as solar energy that allows a home to produce electricity.
Land as a productive factor is a very important component in certain productive and entrepreneurial activities, such as in agriculture or construction, whereas in more modern and technology-related sectors it is far less relevant and in some cases has no relevance at all, such as innovative start-ups, or consultancy firms, that could implement their activities even by renouncing any type of investment on this factor.
Capital is the complex of resources needed to start production, such as the purchase of an oven for a baker who wants to open a business. Capital is usually composed of capital goods or monetary amounts.
In the case of capital goods, we mean goods produced in other production processes and therefore includes machinery, equipment, etc., while monetary amounts are the sums needed to advance production expenditure.
Another possible subdivision for capital is that in fixed and working capital. We often speak of fixed capital when we refer to goods that can be used in several production processes, and therefore used several times, as many industrial machinery. On the other hand, goods that have a shorter life cycle and therefore have to be replaced after each production cycle, such as flour in the case of the baker, are part of the circulating capital.
Capital as a productive factor has been treated in different ways by the various schools of thought which have contributed to the economic debate throughout history. According to classical theory, capital created by labor must be considered a product destined to the production of additional riches, while according to neoclassical thought, capital originates in the behavior of some individuals, the capitalists, who renounce the immediate consumption of resources in the face of obtaining a higher income in the future, usually in the form of interest.
The labor factor includes the employment of different types of human activity, in detail the forces of the body and intellectual work in productive activity. In other words it can be considered as the effort employed by one or more individuals to bring a product or service to the market.
Intellectual work, especially in recent years, is becoming increasingly important as a result of the evolution of the labour market and the emergence of new professions, driven by the use of new technologies.
In the past, classical economists gave great importance to this productive factor as it was considered the only true source of production and therefore the only true source of wealth, while it did not take long for it to be clear that only labor, without an important contribution from other factors of production, it does not have a great importance.
Labor differs from other factors of production because it is made up of people in the role of workers, and for this reason it maintains a very important role in society. In fact, any modification to this factor could have a very serious impact on the living standards of the population and consequently also on the markets as a change in workers’ wages, can have a huge impact on the economy as a whole, because they are often the main component of consumption and therefore of demand.
Entrepreneurship or organization can be considered a fourth factor of production as it is the component that can combine all other factors of production to create a product or service that will then be sold on the market. This activity is usually carried out by the entrepreneur, who has the role of deciding how much to produce, to buy the productive factors that he considers necessary, and therefore coordinate them and taking the risks associated with the performance of an activity.
Even though it is not commonly considered among the factors of production, lately its centrality and its relevance within each production process has become increasingly evident and obvious. In fact, without this component, the other factors of production would lose meaning because the meeting points and the strategies necessary for the implementation of any project would be missing.
The role of the entrepreneur, who carries out the activities listed in the previous paragraphs, shall be remunerated with the profit obtained from the performance of the business activity. However, one peculiarity that this factor has is that profit is not determined a priori and can therefore be positive or negative. This higher level of risk is however assumed by the entrepreneur because he expects to be able to obtain a much higher return if the economic result at the end of the year was positive, thus justifying the greater risk.