Unit 1.5 - Factors of Production

Introduction to Factors of Production

Production is creation of utility and value of goods and services. Technically it is the process of transforming input into output. For example: processing of wheat into flour, converting wood into chair etc. In both of these examples, making flour and chair creates utility. Their value is also higher than wheat and wood respectively.

Production process takes place only after the combined effort of different sources or goods and services. Thus, production is possible only after the use of various resources in production process. The various resources used to produce different goods and services are known as the factors of production or factor input. In economics, generally, the factors of production are categorized into land, labor, capital and organization. Land and labor are original or primary factors of production because they are originated by nature. Capital and organization are produced or derived factors of production because they are derived by the primary factors.

According to Prof. Benham “All goods and services which help in the process of production are called factors of production.”

The above-mentioned factors of production are discussed separately as follows:

Land

The term ‘Land’ in economics is often used in a wider sense. It does not mean only the surface of the soil, but it also includes all those natural resources which are the free gifts of nature.

It, therefore, means all the free gifts of nature. These natural gifts include: (i) rivers, forests, mountains and oceans; (ii) heat of sun, light, climate, weather, rainfall, etc. which are above the surface of land; (iii) minerals under the surface of the earth such as iron, coal, copper, water, etc.

According to Marshall, “By land is meant not merely land in a strict sense of the word but whole of the materials and the forces which nature gives freely for man's aid, in land and water, in air and light and heat.”

Characteristics of Land

There are various characteristics of land which are mentioned below.

1. Free Gift of Nature and Costless

Land is not the outcome of human labor. Rather, it existed even long before the evolution of man. Land is free gift of nature. Land is naturally given to us at free of cost. We can neither create it nor can destroy. We can only improve it or make it more useful. So, initial supply price of land is zero. As we use land for various productive activities, it becomes scarce and it holds price. The price of land is determined according to its productivity and use.

2. Fixed/Limited in Supply

Land is fixed in supply. Nature itself has fixed its quantity. So, no one can enlarge or reduce the size of land. Thus, land is inelastic in supply.

3. Immobile and Permanent

Land is a naturally fixed factor of production. So, it cannot be shifted or moved from one place to another according to our necessity like other factors. Its position remains fixed forever as permanent factor.

4. Passive Factor of Production

Land is a passive factor of production. Land itself cannot produce anything. Without the use of other factors of production like labor, capital and organization we cannot get any output from it. So, it is passive or inactive factors of production.

5. Used for Various Purposes

Land is used for various purposes. For example, somewhere it can be used for fisheries and elsewhere for poultry farming, constructing building, road and so on. The value of land depends on the use of land.

6. Differs in Quality/Suitability

Fertility or quality of land differs from place to place. For example, in Nepal's land of Terai are more fertile as compared to land of hilly and mountain area. Similarly, all lands are not suitable for all purposes. Land in urban area is suitable for construction and can produce high rent and high market value. On the contrary, land in rural sector is suitable for farming; it can produce less rent and low market value.

7. Law of Diminishing Return Operates in Land

As we make more and more intensive use of land, by employing more and more units of labor and capital, the additional output of land will decrease after a certain stage. Thus, law of diminishing return operates in land.

8. Land has Some Original Indestructible Powers

There are some original and indestructible powers of land, which a man cannot destroy. Its fertility may be varied but it cannot be destroyed completely.

Labor

Labor is primary or original factor of production. It is the only one active factor of production. In general, labor refers to the physical work. But in economics, only physical work is not defined as labor. It refers to the use of body or mind of human being, partly or wholly, with the aim of earning reward (money). So, effort of teacher, worker, lawyer, doctor all are labor. Any effort made without expecting any economic advantage or income is not called labor in economics. For example, reading story for time pass, singing and dancing for entertainment, playing for exercise, watching movie for pleasure, etc. cannot be labor as they do not generate income.

According to Marshall, " By labor is meant the economic work of man whether done with the hand or the hand".

According to S.E. Thomas, “labor is all human efforts of body or mind which are undertaken in the expectation of reward.”

Characteristics of Labor

1. Active Factor of Production

Factors of production like land, capital are passive in nature. Their use for production becomes useless in the absence of labor. Hence, labor is an active factor of production.

2. Labor is Perishable

Labor refers to the effort made by man for earning income. And such effort cannot be stored and used at desired time and location. For example, if a worker does not work today s/he loses his effort. S/he cannot store today's effort or labor and use it for tomorrow. Thus, labor can neither be restored nor postponed nor accumulated for the next time period. It is highly perishable in nature.

3. Labor is Not Homogeneous

Each worker has distinct feature and quality as compared to others. So, labor also is not homogeneous in nature. Efficiency of labor differs due to physical as well as mental capabilities inherent with workers as well as education and training taken by them. 

4. Labor is Less Mobile

Labor is a mobile factor of production. It can be transferred from one place to another place and from one occupation to another occupation. But it is less mobile as compared to capital due to social, cultural economic factors. However, some workers can shift from one place to another for their better life.

5. Labor cannot be Separated From the Worker

Worker is the source of own labor. So, the working capacity or the power of labor cannot be separated from the worker or owner like that of capital and land. Presence of labor is necessary in the field where it is used or sold.

6. Weak Bargaining Power

Labor is perishable and his labor cannot be preserved for future to sell when price is high. Hence, they have weak bargaining power.

7. Inelastic Supply

As supply of labor depend upon the size of population and size of population cannot be increased or decreased instantly as demanded. Thus, supply of labor is inelastic.

8. Both Means and an End

A laborer is both a means of production as well as the end of it. He produces goods and consumes them. The demand for goods is mostly linked with the level of wages.

9. Laborer Sells Labor Not Himself

A laborer sells his working capacity or the labor but does not himself. Sale of labor is the basis of the wage earning of a laborer. They do not sell their identity, body, etc. for the cost of any economic benefit.

Capital

In general money or wealth is known as capital. But in economics, capital refers to that part of man-made wealth which is used for the further generation of wealth. Thus, capital is the man-made physical goods used to produce other goods and services or wealth. Money, machinery, factory buildings, plants, raw materials, means of transport, etc. are the examples of capital and they are used in production.

For instance, if a man has an income of Rs. 10,000 per month and out of it he invests Rs. 6,000 in a business, this amount of Rs. 6000 is called capital. In the same way, plough, tractor and other agricultural implements of farmers are also capital. The house in which a man resides is his wealth and the house which is given on rent is his capital. Similarly, all money is not capital. Money includes currency notes and coins which are circulated or minted by the government. Only that part of money which is used for production of more income is called capital.

Chairs and cots (bed) used in the home are wealth, but if these are given on rent they are called capital. There is difference between capital and wealth. Only that part of wealth which is used for further production is called capital. Therefore, all capital is wealth but all wealth is not capital. The capital is explained as physical capital and financial capital. Although, physical capital and financial capital are conceptually distinct, they are closely connected. Physical capital refers to all the machines, factories, computers etc. Financial capital is the fund (money) which is used to start business or to expand business. Financial capital is used to purchase physical capital. It may be used to pay workers for a while until the firm starts to earn revenue.

According to Marshall, “Capital consists of those kinds of wealth other than free gifts of nature, which yield income”.

Characteristics of Capital

1. Man-made Factor

Capital is the man-made factor of production. It is not self-created. So, it is also known as derived factor of production. It helps for further production of goods and services. Buildings, machines, means of transport, etc. are the examples of capital that are made by man.

2. Passive Factor

Capital is a passive factor of production without the active aid of labor it becomes useless. Even automatic machine needs the help of human to work.

3. Perishable Factor

Capital can be used for a number of years. But its value decreases during use in production. So, it has a certain life span. After certain time period of use it can not be used more. Either it should be repaired or replaced. So, it is temporary or perishable in nature.

4. Mobile Factor

Capital is mobile factor of production as compared to labor and land. Capital has the quality of durability, divisibility and portability. So, it can be moved from one place to another place and used for production purposes.

5. Elastic in Supply (Variable Factor)

Capital is elastic in nature. As it is a man-made factor, its supply can be increased or decreased as per the need. The supply of capital assets can be increased through higher saving.

6. Depreciable

Capital is the man made physical good. So, after using it up to a particular time period, its efficiency may decrease and the value of capital goes on depreciating. Hence, there should be period wise maintenance of capital as well as replacement of parts of capital. Thus, capital is depreciable and perishable factor of production.

7. Means of Profit and Satisfaction

Effective use of capital in productive business may provide profit to the entrepreneurs. Those people who invest capital are subject to earn profit and it also provides satisfaction to the people. For example, a car helps not only earn income and profit to manager but also provides satisfactions while travelling.

Organization

Like land, labor and capital, organization is also an important factor of production. Organization is a collective form of people engaged for combining different factors of production for the production of various goods and services. Organization itself is regarded as one of the separate but active factors of production. It does the work of utilizing various factors of production like Land, labor, capital.

One who establishes an organization for producing goods and services is called entrepreneur. The entrepreneur is the leader of organization who coordinates all the factor of production, pays reward for other factor of production and gets profit as residual income. The entrepreneur plans business activities, starts the business, manage the business and supervise. The tasks of collecting other factors of production (initiation), managing them in right proportion, allocating all the factors of production, direction and supervision, control, risk bearing in production process and innovation etc. are the major function of an organization.

According to L.A. Allen, “Organization is the process of identifying and grouping the work to be done, defining and delegating responsibility and authority and establishing the relationship for the purpose of enabling people to work most effectively to obtain the objectives.”

Forms of Organizations

Forms of organization indicate the way the organization operates: its liability, acquisition of capital, ownership, legal formalities, profit sharing mechanism, etc. The forms of business organization differ from country to country. But generally, there are three forms of business organization. They are: (1) Sole proprietorship or individual organization (2) Partnership and (3) Joint stock company

1. Sole proprietorship or individual organization

Sole proprietorship is the simplest form of business organization. It is owned, managed and controlled by single person. So, the size of business is generally small and number of employees is also small. The proprietor is responsible for both the profit and loss made by his organization. Telephone booths, book stationeries, grocery store, etc. are the examples of sole proprietorship.

Similarly, small and cottage industries are the examples of sole proprietorship or individual organization. In Nepal, it should be registered under private firm registration 2014.

Features

• Run by individual
• Managed, owned and controlled by single person.
• Unlimited liabilities
• Single person is responsible for profit and loss
• High freedom

2. Partnership company

The business organization managed or owned by two or more than two proprietors is called partnership firm. There is mutual agreement between or among the owners regarding use of money, labor, skill, share of profit, etc. Investment companies, finance companies, etc. are the examples of Partnership organization. It is not necessary for every partner to participate actively in the operations of the firm. Sometimes a partner contributes his capital but does not participate in management. Such partner is known as Sleeping Partner .

In Nepal Partnership firm should be registered under Partnership Act 2020. According to this act “Partnership means any business registered in the book of Nepal Government, which is carried by some persons with one name for sharing the profits with the agreement to participate all partners for each partner or a partner for all partners in the transactions”.

According to Prof. Haney, "persons competent to make contract who agree to carry on a  lawful business in common with a view of private gain."

Features

• Group of two or more people
• Participation in loss and profit (unlimited liability)
• Legal and mutual agreement for capital investment, distribution of profit, ownership right, responsibility, participation in business organization
• Single or same name of the enterprise
• Joint responsibility
• No separation between owner and manager
• The partners may active or passive
• The share or ownership of partnership is not transferable
• Partnership business can be terminated through the agreement of all partners.

3. Joint Stock Company

Joint stock company is the modern form of business organization. It is an association of individuals (known as shareholders) who are authorized by the government to run a particular business. In Nepal, joint stock company should be registered under Nepal Company Act 2063.

According to Prof. Heney, "It is an artificial person created by law having a separate entity with a perpetual succession and a common seal. It is a voluntary association of individuals for profits, having a capital divided into transferable shares, the ownership of which is the condition of membership."

Types of Joint Stock Company

Private Company

A company which is stablished and operated by private individual and origination with at least one and maximum fifty members with a profit motive, rather than services under company act 2063 BS.is called private company. There is difficulty to transfer their share to the general public for its members without taking permission of other shareholders. It does not need to publish its profit and loss account, balance sheet and annual reports for public knowledge. The word 'Pvt. Ltd.' is used at the end of its name.

Public Company

A company which is established with the motive of service as well as profit earning with at least seven members and limited liability under company act 2063 BS is called public company. The maximum number of members is not limited in public company. There is easy transfer of the share to general people in public company. Through stock exchange, the share is sold and purchased of public company without the permission of its other shareholders. Company must publish its loss and profit reports from time to time (quarterly, annually) for the public knowledge. The word "Limited (Ltd.)" must be writer at the end of its name.

Distinguish between Partnership and Joint Stock company

Basis	Partnership	Joint Stock Company
Meaning	Two or more people come together for doing some business and making profit.	It is voluntary association, artificial person created by law having a common seal and perpetual succession.
Formation	Relatively easy, less legal formalities involved	Formation difficult, too many legal formalities involved
Capital	It can raise limited capital due to limitation on the number of members and the capacity	It can raise large capital due to large members
Liability	Unlimited, joint	Limited
Ownership and management	No difference	Difference
Flexibility	More flexible	Less flexible
Continuity and Stability	Lacks continuity and stability, business may come to an end with death, insolvency and insanity of partners	It is continuous and  stable; business does not come to an end with death, insolvency or insanity of partners
Business Secrecy	Can be maintained to a certain extent	No business secrecy
Government Regulation	Minimum government regulation	Strict and excessive government regulation
Taxation	Less compared to joint stock companies	Subject to heavy taxation
Decision Making	Quick	Delay
Economies of Scale	Less	Enjoys economies of scale
Bargaining Power	Weak	Strong
Contract with Customers and Employees	Close contact	No contact

Quiz: Factors of Production
Video Link: Factors of Production (Land, Labor, Capital and Organization)