Factors of Production: Classification and Importance

In this article we will discuss about Factors of Production. After reading this article you will learn about: 1. Classification of Factors of Production 2. Importance of Factors of Production.

Classification of Factors of Production:

A factor of production may be defined as that good or service which is required for production. A factor of production is indispensable for production because without it no production is possible. It is customary to attribute the process of production to three factors, land, labour and capital, to which we add organisation.

1. Land:

In economics, land as a factor of production does not refer only to the surface of land but to all gifts of nature, such as rivers, oceans, climate, mountains, fisheries, mines, forests, etc.

In the words of Dr. Marshall “By land is meant materials and forces which nature gives freely for man’s aid, in land, water, in air, light and heat.” Land is, thus, an important factor of production which helps in the production of goods and services in one way or the other.

2. Labour:

Labour refers to all mental and physical work undertaken for some monetary reward. It includes the services of a factory worker, a doctor, a teacher, a lawyer, an engineer, an officer, etc. But labour does not include any work done for leisure or which does not carry any monetary reward.

A person painting for leisure, singing a song to entertain his friends, or attending to his garden would not be considered to have done any labour in the sense of economics. On the other hand, if a person sells his paintings, a singer sings a song for a film and a gardener looks after a garden in payment for money, their services are regarded as labour. Thus labour is essential for production.

3. Capital:

Capital means all man-made resources. It comprises all wealth other than land which is used for further production of wealth. It includes tools, implements, machinery, seeds, raw materials and means of transport such as roads, railways, canals, etc.

In modern usage, capital not only refers to physical capital but also to human capital which is the “process of increasing knowledge, the skills and capacities of all people of the country.” It is this human capital which is regarded more important than physical capital in production these days.

As pointed out by Prof. Galbraith, “We now get the larger part of our industrial growth not from more capital investment but from investment in men and improvements brought about by improved men.”

Organisation:

Land, labour and capital are respectively natural, human and material means of production No production is possible without bringing together these three factors of production and employing them in right proportions.

So there must be somebody to hire them from their owners by paying rent wages and interest, and to decide the quantities of each needed for production, This is known as organisation. Organisation refers to the services of an entrepreneur who controls, organises and manages the policy of a firm innovates and undertakes all risks.

Criticisms:

The above classification of factors has come in for criticisms at the hands of many economists. Benham has objected to the wider meaning of land as a factor of production. According to him, it is more convenient to consider only the land which can be bought and sold as a factor of production, rather than such elements as sunshine, climate, etc. which do not enter directly into costs.

Similarly, it is wrong to group together the services of an unskilled worker with that of an engineer, or of an engine driver with that of a waterman in the railways.

Again, there is little point in grouping together as capital, as diverse as canals, diesel, seeds and machinery it would, therefore, be more accurate to lump together all homogeneous units, whether hectares of land workers or capital goods, and to consider each group as a separate factor of production. This method gives us a large number of factors of production and each group is regarded as a separate factor.

Again, the distinction between land, labour and capital is not clear. To take land and capital it is said that land is a gift of nature whose supply cannot be increased while capital is man-made whose supply is changeable.

This is not correct because the supply of land can also be increased by clearing it, draining and irrigating it and fertilizing it by the efforts of man and capital. The “supply of land” does not refer to its area alone, but to its we might regard each unit of a factor as distinct from other units of that factor, but one factor can be substituted for some other factor.

For instance, land can be used intensively by employing more labour or more capital in the form of fertilisers, better seeds and superior techniques. By so doing, we substitute labour or capital for land. Similarly, labour can be substituted for capital, and capital for labour in a factor.

In the former case, labour-intensive techniques are used and in the latter case capital-intensive techniques are used I he degree of substitution of one factor for another will, however, depend on the most efficient method of production to be used relatively to the cost of the factor to be substituted.

Further, we find that land, labour and capital often get intermixed into one another and it is difficult to specify the contribution of each separately. For instance, when land is cleared, canals are dug and fences are erected the productivity of land increases.

But all these improvements on land are possible by making capital investments and through labour. In such a situation, it is not possible to specify the contribution of land, labour and capital in increasing productivity.

Similarly, the amount of money spent on educating and training workers is included under capital. So, when such workers produce goods by operating machines in a factory, they put in their labour as well as skills acquired through capital investments on them) by using raw materials which are also the product of labour and machines used on land.

Thus it is difficult to disentangle the contribution of land, labour and capital in such cases.

The problem arises as to whether the contribution of land, labour and capital should be taken as such, or of their services. If the community is to plan for the future or find out the production possibilities open to it, then the contribution of the factors of production should be considered.

Keeping the future in view, land may be put to more productive uses, labour may be trained for different occupations requiring higher skills, and capital may be used for producing more roundabout methods of production and machinery.

Thus the central economic problem for any community is how to make the best use of its labour and other resources, and for this purpose the community must consider the various alternatives. It must consider what the men and the land and the capital might contribute towards output if they were used in different ways, and not merely what in fact they are contributing now.

But when we consider the services rendered by the factors of production, they should be taken in terms of inputs and outputs. An input is obtained but an output is produced. It is the services of factors of production that form part of the inputs which help in producing the outputs.

Coal is an input for steel industry, and is thus a factor of production. Similarly, steel is an input for coal industry and hence it is also a factor of production. Thus the input of one industry may be the output of another industry, and vice versa.

But coal and steel as inputs of their respective industries are the results of the services rendered by land, labour and capital in producing them. Lastly, it is customary not to treat organisation as distinct from labour. This is misleading and underestimates the role of the entrepreneur as a factor of production, as a matter of fact; labour and entrepreneur are quite distinct from each other.

An entrepreneur is a man of special managerial abilities who controls, organises and manages the entire business of a firm. It is he who employs all types of workers and puts them at the places where they are the most suited by virtue of their education and training. In a firm, there is only one entrepreneur but the workers are many.

An entrepreneur can run any number of firms simultaneously but a worker can work only at one job at a time. Above all, the entrepreneur undertakes all risks of his business. He may earn profits which may be high or low, or he may incur losses.

But the workers are free from all risks of the business They get their salaries or wages whether the firm is earning profits or incurring losses. Thus from all counts the entrepreneur is a separate factor of production. It is the only positive and active factor, the other factors land, labour and capital being merely a heterogeneous mass of productive resources. By combining them judiciously, he keeps the wheels of production moving in the most economical manner.

Importance of Factors of Production:

The concept of the factor of production is of great importance in modern economic analysis. It is used in the theory of production in which the various combinations of factors of production help in producing output when a firm operates under increasing or decreasing costs in the short-run, and when the returns to scale increase or decrease in the long-run.

Further, we can also know, how can the least-cost combination of factors are obtained by a firm?

The theory of cost of production also depends upon the combinations of factors employed in business and the prices that are paid to them. From the point of view of the theory of costs of production, factors of production are divided as fixed factors and variable factors. Fixed factors are those whose costs do not change with the change in output, such as machinery, tube well, etc.

Variable factors are those whose quantities and costs change with the change in output. Larger outputs require larger quantities of labour, raw materials, power, etc.

So long as a firm covers the costs of production of the variable factors it employs, it will continue to produce even if it fails to cover the costs of production of the hired factors, and incurs a loss. But this is only possible in the short-run.

In the long-run, it must cover the costs of production of both the fixed and variable factors. Thus the distinction between fixed and variable factors is of much importance for the theory of firm.

Factors of production are also divided into divisible and indivisible factors. Factors are divisible when their inputs can be adjusted to the output. Labour is said to be divisible when the number of labourers may be reduced in keeping with the output of the firm. Divisible factors lead to the economies of scale for a firm by adjusting the number of factors to the output of the firm.

Indivisible factors are those which are available in minimum sizes, and are lumpy, such as machines, entrepreneur, etc. They also lead to economies of scale, but at a faster pace. When a firm expands, the returns to scale increase because the indivisible factors are employed to their maximum capacity. More output can be had by using the existing machines up to their full productive capacity.

Lastly, the concept of factor of production is used in explaining the theory of factor-pricing. For this purpose, factors of production are divided into specific and non-specific. A factor of production which is specific in use earns a higher reward than a non-specific factor. This also solves the problem of distribution of income to the various resource-owners.