4 Factors of Production Explained With Examples

What Are Factors of Production?

The factors of production are land, labor, entrepreneurship, and capital. These inputs are needed for the creation of goods and services. Those who control the factors of production often enjoy the greatest wealth in a society. In capitalism, the factors of production are most often controlled by business owners and investors. In socialist systems, the government exerts greater control over the factors of production.

Key Takeaways

  • Factors of production is an economic term that describes the inputs used in the production of goods or services to make an economic profit.
  • These include any resource needed for the creation of a good or service.
  • The factors of production are land, labor, capital, and entrepreneurship.
  • The state of technological progress can influence the total factors of production and account for any efficiencies not related to the four typical factors.
  • Land as a factor of production can mean agriculture and farming as well as the use of natural resources, and even land to construct buildings on.
Factors of Production

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How Factors of Production Work

The modern definition of factors of production is primarily derived from a neoclassical view of economics. Initially, only labor was considered by most economists, but eventually, land and capital were considered as well. Entrepreneurship is a slightly more recent addition to the list as it was formerly lumped in with capital.

Labor was the original factor of production identified by early economists such as Adam Smith and David Ricardo. In the early 20th century, two Swedish economists named Bertil Heckscher and Eli Ohlin were the first to expand the factors of production beyond labor. Production, such as manufacturing, can be tracked by certain indexes, including the ISM manufacturing index.

The 4 Factors of Production

There are four factors of production—land, labor, capital, and entrepreneurship.

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Image by Sabrina Jiang © Investopedia 2020

Land As a Factor

Land has a broad definition as a factor of production and can take on various forms, from agricultural land to commercial real estate to the resources available from a particular piece of land. Natural resources, such as oil and gold, can be extracted and refined for human consumption from the land.

The cultivation of crops on land by farmers increases its value and utility. For a group of early French economists called “the physiocrats,” who predated the classical political economists, land was responsible for generating economic value.

While land is an essential component of most ventures, its importance can diminish or increase based on industry. For example, a technology company can easily begin operations in the founder's home with zero business investment in land. On the other hand, land is the most significant investment for a real estate venture.

Labor As a Factor

Labor refers to the effort expended by an individual to bring a product or service to the market. Again, it can take on various forms. For example, the construction worker at a hotel site is part of the labor, as is the waiter who serves guests or the receptionist who enrolls them into the hotel.

Within the software industry, labor refers to the work done by project managers and developers in building the final product. Even an artist involved in making art, whether it is a painting or a symphony, is considered labor. For the early political economists, labor was the primary driver of economic value.

Production workers are paid for their time and effort in wages that depend on their skill and training. Labor by an uneducated and untrained worker is typically paid at low prices. Skilled and trained workers are called “human capital” and are paid higher wages because they bring more than their physical capacity to the task.

For example, an accountant’s job requires the analysis of financial data for a company. Countries that are rich in human capital experience increased productivity and efficiency. The difference in skill levels and terminology also helps companies and entrepreneurs create corresponding disparities in pay scales.

This can result in a transformation of factors of production for entire industries. An example of this is the change in production processes in the information technology (IT) industry after jobs were outsourced to countries with lower salaries.

Capital As a Factor

In economics, capital typically refers to money. However, money is not considered part of the capital factor of production because it is not directly involved in producing a good or service. Instead, it facilitates the acquisition of things that are considered capital such as capital goods.

Capital goods are items that allow a person or business to produce goods and services. For example, the machinery in a factory, the computers of a tech company, and the instrument of a musician are capital goods. For modern mainstream (neoclassical) economists, capital is the primary driver of value.

It is important to distinguish personal and private capital in factors of production. A personal vehicle used to transport family is not considered a capital good, but a commercial vehicle used expressly for official purposes is.

During an economic contraction or when they suffer losses, companies cut back on capital expenditure to ensure profits. However, during periods of economic expansion, they invest in new machinery and equipment to bring more products to market. This investment further feeds economic growth.

An illustration of the above is the difference in markets for robots in China compared to the United States after the 2008 financial crisis. After the crisis, China experienced a multi-year growth cycle, and its manufacturers invested in robots to improve productivity at their facilities and meet growing market demands.

As a result, the country became the biggest market for robots. Manufacturers within the United States, which had been in the throes of an economic recession after the financial crisis, cut back on their investments related to production due to tepid demand.   

As a factor of production, capital refers to the purchase of goods made with money in production. For example, a tractor purchased for farming is capital. Along the same lines, desks and chairs used in an office are also capital.

Entrepreneurship As a Factor

Entrepreneurship is the secret sauce that combines all the other factors of production into a product or service for the consumer market. An example of entrepreneurship is the evolution of the social media behemoth Meta (META), formerly Facebook.

Mark Zuckerberg assumed the risk for the success or failure of his social media network when he began allocating time from his daily schedule toward that activity. When he coded the minimum viable product himself, Zuckerberg’s labor was the only factor of production.

After Facebook became popular and spread across campuses, Zuckerberg realized he needed to recruit additional employees. He hired two people, an engineer (Dustin Moskovitz) and a spokesperson (Chris Hughes), who both allocated hours to the project, meaning that their invested time became a factor of production.

The continued popularity of the product meant that Zuckerberg also had to scale technology and operations. He raised venture capital money to rent office space, hire more employees, and purchase additional server space for development. At first, there was no need for land. However, as business continued to grow, Meta built its own office space and data centers. Each of these requires significant real estate and capital investments.

Connecting the Factors

Another example of entrepreneurship is Starbucks Corporation (SBUX). The retail coffee chain needs land (prime real estate in big cities for its coffee chain), capital (large machinery to produce and dispense coffee), and labor (employees at its retail outposts for service).

Entrepreneur Howard Schultz, the company’s founder, provided the fourth factor of production by being the first person to realize that a market for such a chain existed and figuring out the connections among the other three factors of production.

While large companies make for excellent examples, a majority of companies within the United States are small businesses started by entrepreneurs. Because entrepreneurs are vital for economic growth, countries are creating the necessary framework and policies to make it easier for them to start companies.

Ownership of Factors of Production

The definition of factors of production in economic systems presumes that ownership lies with households, who lend or lease them to entrepreneurs and organizations. But that is a theoretical construct and rarely the case in practice. Except for labor, ownership for factors of production varies based on industry and economic system.

For example, a firm operating in the real estate industry typically owns significant parcels of land, while retail corporations and shops lease land for extended periods of time. Capital also follows a similar model in that it can be owned or leased from another party. Under no circumstances, however, is labor owned by firms. Labor’s transaction with firms is based on wages.

Ownership of the factors of production also differs based on the economic system. For example, private enterprises and individuals own most of the factors of production in capitalism. However, collective good is the predominating principle in socialism, at least in theory.

As such, factors of production, such as land and capital, are owned partially or fully by the government under socialism and communism. As we have seen in history, the implementation has never matched the promises of the idealist theory with the factors of production usually being used for the benefit of those ruling the country rather than the common good in communist systems.

Ownership of the factors of production depends on the type of economic system and society
Factors of Production Capitalism Socialism Communism
Are owned by... Individuals Individuals and government; the government typically owns large and essential industries Government

The Role of Technology

While not directly listed as a factor, technology plays a vital role in influencing production. In this context, technology has a fairly broad definition and can refer to software, hardware, or a combination of both used to streamline organizational or manufacturing processes.

Increasingly, technology is responsible for the difference in efficiency among firms. To that end, technology—like money—is a facilitator of the factors of production. The introduction of technology into a labor or capital process makes it more efficient. For example, the use of robots in manufacturing has the potential to improve productivity and output. Similarly, the use of kiosks in self-serve restaurants can help firms cut back on their labor costs.

The Solow residual, also known as "total factor productivity (TFP)," measures the residual output that remains unaccounted for from the four factors of production and typically increases when technological processes or equipment are applied to production. Economists consider TFP to be the main factor driving economic growth for a country. The greater a firm's or country's TFP, the greater its growth.

What Are the Factors of Production?

The factors of production are an important economic concept outlining the elements needed to produce a good or service for sale. They are commonly broken down into four elements: land, labor, capital, and entrepreneurship. Depending on the specific circumstances, one or more factors of production might be more important than the others.

What Are Examples of the Factors of Production?

Land refers to physical lands, such as the acres used for a farm or the city block on which a building is constructed. Labor refers to all wage-earning activities, such as the work of professionals, retail workers, and so on. Entrepreneurship refers to the initiatives taken by entrepreneurs, who typically begin as the first workers in their firms and then gradually employ other factors of production to grow their businesses.

Finally, capital refers to the capital goods needed to start or grow a business. These can include things such as factory machinery, tractors, and computers—basically any items needed to run a given business.

Are All Factors of Production Equally Important?

Depending on the context, some factors of production might be more important than others. For example, a software company that relies primarily on the labor of skilled software engineers might see labor as its most valuable factor of production. Meanwhile, a company that makes its money from building and renting out office space might see land and capital as its most valuable factors. As the demands of a business change over time, the relative importance of the factors of production will also change accordingly.

The Bottom Line

The factors of production—land, labor, entrepreneurship, and capital—are necessary for businesses to create products and services to sell to consumers and earn a profit. How companies manage their factors of production is critical to their success.

Article Sources
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  1. The Wilson Center. "Chapter 3: Trade Agreements and Economic Theory."

  2. Federal Reserve Bank of San Francisco. "Sustaining China’s Economic Growth After the Global Financial Crisis." Pages 1 and 2.

  3. International Federation of Robotics. "IFR Presents World Robotics Report 2020."

  4. U.S. International Trade Commission. "The Industrial Robotics Industry in China: Demand and Domestic Innovation."

  5. Association for Advancing Automation. "North American Robot Orders Fall 21% in 2008."

  6. Starbucks Coffee Corporation. "Our Company."

  7. U.S. Small Business Administration. "Frequently Asked Questions About Small Business 2023."

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