The four factors of production are one of the foundations of economic activity. They describe all the inputs or resources that are used in the production of goods and services. The classical factors of production include land, labor and capital. In recent years however, a forth factor has been added to the list; entrepreneurship. The factors of production are sometimes also referred to as producer goods and services, because they are mainly used in the production of other goods and services (i.e. consumer goods and services). Now, let’s look at each of them in more detail.
Land as a factor of production is sometimes also referred to as natural resources. It includes all naturally-occurring resources such as soil, water, air, plants, etc. that can be used in the production process. Land has three important characteristics: (1) its quantity is fixed, i.e. perfectly inelastic, (2) it is immobile, which means it cannot be moved, and (3) it is passive in nature, because it cannot produce anything on its own.
Labor as a factor of production refers to the human effort that is used in the production of goods and services. It includes all physical and mental efforts that are made by employees during the production process. The employees receive wages in exchange for their efforts. Wages are a critical aspect, because they are necessary in order to be able to distinguish between labor and leisure activities.
Capital as a factor of production describes all man-made goods that are used in the production process. The capital stock may include goods such as machinery, tools, vehicles, semi-finished products, etc. It is important to note that capital is by definition a derived factor of production, since it requires the combination of land and labor (i.e. the other two factors of production).
Even though entrepreneurship is not part of the classical factors of production, it is often added to the list as a fourth factor. The reasoning behind this is that entrepreneurship often leads to innovation, new processes or new products. Hence, it can increase production efficiency and act as a factor of production.
In a Nutshell
The four factors of production describe all the inputs or resources that are used in the production of goods and services. The classical factors include land, labor and capital. Land (i.e. natural resources) describes all naturally-occurring resources (e.g. soil, water, air) that can be used in the production process. Labor refers to the human effort that is used in the creation of goods and services. Capital describes all man-made goods that are used in the production process. Last but not least, some economists argue that entrepreneurship should be considered a factor of production as well, because it leads to innovation and thereby increases production efficiency.