The factors of production and their rewards

The four factors

Think of a cup of tea from a roadside stall. The tea leaves grew on land, a person made it, using a stove and a kettle, and someone took the risk of setting up the stall. Those four things are the factors of production: land, labour, capital and enterprise.

Land

Land means all natural resources, not just the ground. It includes farmland, forests, rivers, the sea, fish, oil, gas and minerals. So the oil in the ground is land, but an oil well is not. The well was made by people, so it is capital. The reward for land is rent. A farmer who rents a field pays the owner rent for using it.

Labour

Labour is the human effort, physical and mental, used to make goods and services. Doctors, teachers, farm workers and drivers all supply labour. The quantity of labour is how many workers there are and how many hours they work. The quality is how skilled and productive they are. The reward for labour is wages. A worker gives time and effort, and receives a wage or salary.

Capital

Capital means man-made goods used to make other goods and services: machines, tools, factories, delivery vans and computers. Capital is not money in economics. Money is used to buy capital goods. Buying new capital goods is called investment. The reward for capital is interest, the return to those who provide the funds for capital.

Enterprise

Enterprise is the willingness and ability to bring the other three factors together and take the risk of producing. The entrepreneur decides what to make and how. If the business does well, they keep the profit. If it fails, they bear the loss. The reward for enterprise is profit. It is the only reward that can be negative, a loss.

Factors and their rewards

Here are the four pairs. Cambridge often asks you to identify two of them, so learn every pair exactly.

More land, better land

The quantity of land can increase. Land can be reclaimed from the sea, new oil or minerals can be discovered, and fish stocks can recover if overfishing stops. The quality of land can rise too, with fertilisers, irrigation and better farming methods that keep the soil rich. Land can also fall in quantity or quality: floods wash soil away, and pollution or deforestation damages it.

More labour, better labour

The quantity of labour rises when the population grows, when more people move into the country, or when the retirement age goes up. The quality of labour rises with education, training and better health care. A healthier, better-trained worker produces more in an hour. Emigration reduces both: when skilled workers leave, the country loses their numbers and their skills.

More capital, more enterprise

The quantity of capital rises when firms and the government invest in new machines, factories and roads. The quality rises with new technology. Enterprise rises when it pays to take risks: lower taxes on profit, lower interest rates for borrowing, and less red tape to start a business. Enterprise falls when profits are taxed more, when interest rates rise, or when the economy is weak and success looks unlikely.

Why the changes matter

More factors, or better ones, mean the economy can produce more goods and services. Its production possibility curve moves outwards. Fewer factors, or worse ones, mean it can produce less. In the next lesson you will draw both of these on a diagram. When you answer, always link the change in the factor to a change in output.

One product, four factors

Here is the cup of tea again, taken apart into its four factors, each with the reward it earns.

Mistakes that lose marks

Mistake one: calling money capital. In economics, capital means machines, tools and buildings. Mistake two: giving the reward for labour when the question asks for capital and land. Read which factors are named. Mistake three: explaining why land is used more, when the question asks why the quantity of land increases. The fix: name the factor, define it, and give its reward exactly: rent, wages, interest, profit.

The full-marks tip

The full-marks tip: learn each factor with its reward as a pair, and give an example of each. For a change in quantity or quality, give the cause and then its effect on output.

On one card

So, on one card: the factors of production. Keep it for revision.