Factors of production are inputs used to produce an output, or goods and services. 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.

Factors of Production

Land is the natural resource that an enterprise uses to produce goods and services to generate a profit. 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 laborers and workers perform that contributes to the production process. For example, if a laborer works and her efforts create a good or service, she contributes to labor resources.

Key Takeaways

  • 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.
  • The primary debate and separation between capitalism and socialism is about the ownership of the primary factors of production.

Capital 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; his capital is the computer he uses. 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 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.

Economic Schools of Thought on Factors of Production

Most economic schools identify the same types of factors of production: land, labor, capital and entrepreneurship (intellectual capital and risk-taking). Monetarist, neoclassical and Keynesian schools of thought are mostly in agreement about who should own the factors of production and their roles in 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 Austrian school is perhaps the most capital-intensive school, suggesting that the structure of the factors of production determines the business cycle.

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.

Austrians contend the factors of production need to be viewed as heterogeneous and time-sensitive.

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 investment as equal and treats all capital goods sales as equal.

The Austrian method stresses that it makes a real difference whether producers build houses or lay down railroad tracks. When 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, for example. 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 is closely tied to the interest rate, Austrians oppose even nominal interest rate controls by central banks.