Factor income is income received from the factors of production—land, labor, and capital. Factor income on the use of land is called rent, income generated from labor is called wages, and income generated from capital is called profit. The factor income of all normal residents of a country is referred to as the national income, and factor income and current transfers together are referred to as private income.

Breaking Down Factor Income

Factor income is most commonly used in macroeconomic analysis, and it helps governments determine the difference between gross domestic product and gross national product. For most countries, the difference between GDP and GNP is small, since the income generated by citizens abroad and by foreigners domestically often offset each other. A large difference in factor income is more likely to be found in small, developing nations, where a significant portion of income may be generated by foreign direct investment.

The proportional distribution of factor income across the factors of production is also important in country-level analysis. Countries with low populations but great mineral wealth may see a low proportion of factor income stemming from labor, but a high proportion stemming from capital. Nations focusing on agriculture may see an uptick in factor income derived from land, though crop failures or declining prices may lead to decreases. Industrialization and increased productivity generally cause rapid shifts in factor income distribution.

How Factor Income Can Expose Disparities in Income Distribution

Examining factor income can be a way to understand the causality behind periods of inequality in income distribution. For example, if a country experiences a rapid advance in technology followed by a move into industrialization, the balance of factor income will shift, at least for a time, away from labor and more towards capital. This is especially pronounced if the country had a long-term reliance on traditional labor to provide private income.

The introduction of technology that does not utilize such labor, or only partially relies on it, means that capital investments into the technology may escalate drastically. As those older forms of labor are phased out, there would be widening income inequality. Wages may decrease significantly for labor during such a transition. Over time, the populace may shift to generate personal income through opportunities in industrialization; however, there will likely be a period wherein only a select portion of the populace will be in a position to tap into the capital that is generated. The degree of change that industrialization brings can have a direct effect on factor income shifts.