Factors of production

In economic theory, factors of production (or productive inputs) are the resources employed to produce goods and services. Here the rate of output is modeled as a function of the rate of use of each input employed.^[1][2]

The first factor of production is the time of the entrepreneur, which, when combined with other factors, determines the rate of output for a particular good or service and the cost to the entrepreneur of various rates of supply.

The choice by the entrepreneur of the rate and volume of the good or service to supply is determined by the extent of the market. Adam Smith When producing in autarky, the extent of the market is the demand by the entrepreneur himself. As additional individuals enter the economy, the market may widen. But, in addition, competitive suppliers might also enter. It is this dynamic system that determines the production of the good or service, and the returns to the relevant factors of production.

Classification of factors can include such broad aggregates as labour, land, capital, the overall state of technology,^[3] and entrepreneurship. The number and definition of factors can vary, depending on theoretical purpose, empirical emphasis, or school of economics.^[4]

[edit] Historical schools and factors

The term "factors" did not exist until after the classical period and is not to be found in any of the literature of that time.

[edit] Physiocracy

In Physiocracy the productive process is explained as the interaction between participating classes of the population. These classes are therefore the factors of production within Physiocracy.

• The farmer labors on land (sometimes using "crafts") to produce food.
• The artisan labors to produce important capital goods (crafts) to be used by the other economic actors.
• The landlord is only a consumer of food and crafts and produces nothing at all.
• The merchant labors to export food in exchange for foreign imports.

[edit] Classical

Classical economics focuses on physical Resources in defining its factors of production, and discusses the distribution of cost/value among these factors. Adam Smith and David Ricardo referred to the "component parts of price" ^[5] as:

• Land or natural resource – naturally-occurring goods such as water, air, soil, minerals, flora and fauna that are used in the creation of products. The payment for land use and the received income of a land owner is rent.
• Labor – human effort used in production which also includes technical and marketing expertise. The payment for someone elses labor and all income received from ones own labor is wages.
• Capital stock – human-made goods (or means of production) which are used in the production of other goods. These include machinery, tools and buildings. The classical economists employed the word capital in reference to money (gold) also. Money however was not considered to be a factor of production in the sense of capital stock. The return to loaned money or to loaned stock was styled as interest while the return to the actual propietor of capital stock (tools, etc) was styled as profit. See Returns (economics)

[edit] Neoclassical economics

Neoclassical economics continued the distinction of land, labor, and capital. It developed an alternative theory of value and distribution. For a modern discussion about problems in defining and theorizing about the neoclassical theory of capital, see capital controversy. GCSE: 4 Main types of production

[edit] A fourth factor?

J.B. Clark gave the co-ordinating function to entrepreneurs; Frank Knight introduced managers who co-ordinate with their own money and the financial capital of others. However, some consider human capital as the last factor of production.

In a market economy, considered as a separate factor, entrepreneurs combine the other factors of production, land, labor, and capital in an innovative way to make a profit. In a planned economy, central planners decide how land, labor, and capital should be used to provide for maximum benefit for all citizens.

Further distinctions from classical and neoclassical microeconomics include the following:

• Capital has many meanings, including the financial capital raised to operate a business. Normally, capital means investment in goods that can produce other goods in the future. It can also refer to machines, roads, factories, schools, and office buildings in which humans produced in order to produce other goods and services. Investment is important if the economy is to achieve economic growth in the future.
• Fixed Capital this includes machinery, work plants, equipment, new technology, factories, buildings, and goods that are designed to increase the productive potential of the economy for future years.
• Working Capital this includes the stocks of finished and semi-finished goods that will be economically consumed in the near future or will be made into a finished consumer good in the near future. It includes also the liquid assets needed for immediate expenses linked to the production process (salaries, invoices, taxes, interests...).

[edit] Free trade and movement of factors of production

Free trade laissez faire theory argues that economic efficiency is achieved in cases where free movement (laissez passer) of the "factors of production" is permitted. Karl Polanyi in "The Great Transformation" argued that historically whenever laissez faire policies are adopted, legal moves to prevent the free movement of one of the factors of production always occur (for example current neo-liberal attempts to free the movement of capital and resources are today increasingly tied to immigration controls), so effiency is in practise rarely reached.

[edit] Human capital and intellectual capital

Contemporary analysis distinguishes capital goods from other forms of capital such as human capital. Human capital is acquired through education and training, whether formal or on-the-job. A more recent coinage is intellectual capital, used especially as to information technology.

Prior to the Information Age the land, labour, and capital were used to create substantial wealth due to their scarcity. During the Information Age (circa 1971-1991), the Knowledge Age (circa 1991 to 2002), and the Intangible Economy (2002-present) the primary factors of production have become less concrete. These factors of production are knowledge, collaboration, process-engagement, and time quality. According to economic theory, a "factor of production" is used to create value and economic performance. As the four modern-day factors are all essentially abstract, the current economic age has been called the Intangible Economy. Intangible factors of production are subject to network effects and the contrary economic laws such as the law of increasing returns. It is therefore important to differentiate between conventional (tangible) economics and intangible economics when discussing issues related to factors of production which change according to the economic era that society is experiencing. For example, land was a key factor of production in the Agricultural Age.

[edit] See also

• Cost of production theory of value
• Factor world
• Labor theory of value
• Microeconomics
• Optimum factor allocation
• Production, costs, and pricing
• Production theory basics
• Productivity world
• Resource-Based View

[edit] References

1. ^ NA (2008). "production, theory of," Encyclopædia Britannica Online.
2. ^ Richard G. Lipsey and C. D. Harbury (1992), First Principles of Economics, 2nd ed., p. 134.
3. ^ Parkin, Michael and Esquivel, Gerardo, Macroeconomía, Addison Wesley, 5ed (1999), p. 160.
4. ^ Milton Friedman (2007), Price Theory, pp. 201-02.
5. ^ Adam Smith (1776), The Wealth of Nations, [1] B.I, Ch.6, Of the Component Parts of the Price of Commodities in paragraph I.6.9.

Condensed Version of AP U.S. History Book. 2007