Factors of Production: Capital and Labour
Factors of production are resources used by firms as inputs for a good or
service to be produced. Factors of production are as follows: capital, labour,
and natural resources.
In economic theory, the term "capital" refers to goods and money used to
produce more goods and money. Classifications of capital vary with the purpose
of the classification. The most general distinction is the one made between
physical, financial, and human capital.
Physical capital is land, buildings, equipment, raw materials; Bonds, stocks,
available bank balances are included in the financial capital. They both make
a great contribution to production.
To group capital into fixed capital and circulating capital is common practice. The former refers to means of production such as land, buildings, machinery and various equipment. They are durable, that is, they participate in the production process over several years. Circulating capital includes both
non-renewable goods, such as raw materials and fuel, and the funds required
to pay wages and other claims against the enterprise. Non-renewable goods
are used up in one production cycle and their value is fully transferred to the
Human capital is knowledge that contributes "know-how" to production.
It is increased by research and disseminated through education. Investment
in human capital results in new, technically improved, products and production
processes which improve economic efficiency. Like physical capital, human
capital is important enough to be an indicator of economic development
of a nation.
It is common, in economics, to understand labour as an effort needed to
satisfy human needs. It is one of the three leading elements of production.
Labour has a variety of functions: production of raw materials, manufacturing
of final products, transferring things from one place to another, management
of production, and services like the ones rendered by physicians and
One can classify labour into productive and unproductive. The former
Produces physical objects having utility. The latter is useful but does not produce
material wealth. Labour of the musician is an example.
Unlike other factors of production, for example capital, once workers are
employed, their efficiency can vary greatly with organization of work and their
Demand for labour is influenced by the demand for goods produced by
fkers, the proportion of wages in total production costs, etc. The supply of labour depends upon the size of population, geographic mobility, skills, education
level (human capital), etc. Workers supply labour either individually or
through trade unions. If demand for and supply of labour are not in equilibrium,
there is unemployment. The rate of unemployment is a percentage of
the total labour force without a job. It is desirable for an economy to have the
lowest possible unemployment rate and to achieve higher employment as neither
full use of resources nor maximum level of output can be achieved in an
economy having unemployment.
Factors of production are combined together in different proportions in
order to produce output. It is assumed in economics that one should choose
the combination of factors which minimizes the cost of production and increases
The third factor of production, natural resources, poses too many economic
problems3 to be discussed here. We will analyze them in the following unit.