Economic growth only comes from increasing quality and quantity of the factors of production, which consist of four broad types: land, labor, capital, and entrepreneurship. The factors of production are the resources used in creating or manufacturing a good or service in an economy.

Understanding the Factors of Production

The factors of production are what's needed for a company to earn an economic profit. The four factors of production are:

Land

Land is any natural resource that's needed or used in the production of a good or service. Land can also include any resource that comes from the land such as oil, gas, and other commodities such as copper and silver. Typically, land includes any natural resource that's used as raw materials in the production process.

Labor

Labor consists of the people that are responsible for the production of a good, including factory workers, managers, salespeople, and the engineers that designed the machinery used in production.

Capital

Capital refers to capital goods such as manufacturing plants, machinery, tools, or any equipment used in the production process. Capital might refer to a fleet of trucks or forklifts as well as heavy machinery.

Entrepreneurship

Entrepreneurship is the fourth factor and includes the visionaries and innovators behind the entire production process. The entrepreneurs combine all the other factors of production to conceptualize, create, and produce the prod vuct or service.

Key Takeaways

  • The factors of production are the resources used in creating and producing a good or service and are the building blocks of an economy.
  • The factors of production are land, labor, capital, and entrepreneurship, which are seamlessly interwoven together to create economic growth.
  • Improved economic growth raises the standard of living by lowering production costs and raising wages.

The Importance of the Factors of Production

According to the Federal Reserve Bank of St Louis, the factors of production are defined as

"Resources that are the building blocks of the economy; they are what people use to produce goods and services." — St. Louis Fed

If businesses can improve the efficiency of the factors of production, it stands to reason that they can create more goods at a higher quality and perhaps a lower price. Any increase in production leads to economic growth as measured by Gross Domestic Product or GDP. GDP is merely a metric that represents the total production of all goods and services in an economy. Improved economic growth raises the standard of living by lowering costs and raising wages.

Capital goods include technological advances from iPhones, to cloud computing, to electric cars. For example, in the last several years, the technology of fracking or horizontal drilling has led to improved extraction of oil making the U.S. one of the world's largest oil producers. The innovation couldn't be done without the labor behind the process, from conceptualization to the finished product.

However, as technology helps to increase the efficiency of the factors of production, it can also replace labor to reduce costs. For example, artificial intelligence and robotic machines are used in manufacturing boosting productivity, reducing costly errors from human beings, and ultimately reducing labor costs.

Of course, nothing gets started without the entrepreneurs who create a vision and the action steps needed to design the production process. Entrepreneurs combine all the factors of production, including buying the land or raw materials, hiring the labor, and investing in the capital goods necessary to bring a finished product to market.

As Parmenides, a Greek philosopher, famously quipped, "Nothing comes from nothing." Economic growth results from better factors of production. This process is clearly demonstrated when an economy undergoes industrialization or other technological revolutions; each hour of labor can generate increasing amounts of valuable goods.