The foundation of an economy is built on the four factors of production: land, labor, capital and entrepreneurship. To understand how these factors apply to a business, consider the story of an entrepreneur, Henry, who has an idea to make an evolutionary toothbrush that eliminates tooth decay. His toothbrush dispenses minute amounts of sap from the baobab tree, a rare tree found only in Africa. While the user brushes, the sap coats the teeth to prevent tooth decay.
Land implies all types of natural resources used to create goods and services. In addition to land, it includes commodities such as gold, timber, oil, copper and water. Resources can also be renewable, such as forests, animals and food.
Henry's toothbrush uses a natural resource – sap from the baobab tree. His plastic toothbrushes are made from another natural resource, petroleum.
Labor is the work performed by employees. The value of their work depends on their education, skills and desire to do a good job. One of the goals of an owner is to train employees to become more skilled to increase their productivity. The output of labor can be both physical and mental.
Labor is a flexible resource. Workers can be allocated to different sectors of the economy for the most productive output.
In the beginning, Henry had to do most of the work himself. It took a while to build up his sales, but eventually, he was making enough profit to hire employees. Henry trained his employees to receive the shipments of sap and toothbrushes and place them in the warehouse. Next, he had other employees trained to operate the machines that injected the sap into small containers in the toothbrushes and placed them in boxes for shipping.
Capital includes the buildings, tools and machines that employees use to make goods and services. Some examples are forklift trucks, automated machines, hammers, computers and delivery vans.
Unlike land or labor, capital must be created by humans and designed for use by humans. In this sense, capital goods become the foundations for buildings, equipment, machinery and processes.
Henry's plant uses several different types of capital. He has forklifts to move products around the warehouse, and he has machinery that assembles the parts. His office uses desks, phones and computers to keep track of everything.
Entrepreneurship is the driving force behind the creation of a business. An entrepreneur finds ways to combine the other factors of production – land, labor and capital – to produce a product and make a profit. The most successful ones are the innovators who create new products to bring to consumers. Henry is an innovator who is bringing a new product to market.
Without these innovative entrepreneurs, many products and services we take for granted in our everyday lives would not exist. Innovators look at the other three factors of production and find new ways to use them. They are willing to take risks to bring their ideas to fruition.
- "Economics in One Lesson"; Henry Hazlitt; 1979
About the Author
In 2007, Jim Woodruff began writing content for e-commerce Web sites and article directories. He specializes in business and finance. Woodruff holds a Bachelor of Mechanical Engineering from the Georgia Institute of Technology and a Master of Business Administration from the Columbia University Graduate School of Business.
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The resources (input) used to produce final products (output) are termed as factors of production.
In economic terms factors of production can be defined as inputs that are used for the production of goods or services with the aim to make economic profit.
The factors, of production are the resources that include land, labor, capital, and enterprise.
Land involves natural resources labor is associated with human resources, capital includes manmade resources, and enterprise combines all the three factor, to carry out the production process. Therefore, all the four factors of production are equally important for the production activity of an organization. According to Eraser, “Factor of production as a group or class of original productive resources.”
The production process of an organization can be efficient, if there is an optimal use of factors. This implies that the factors of production should be used in combination, so that the production target can be achieved. The factors of production can be used as complementary as well as substitute of each other.
For example, if an organization has adequate capital only then it would hire labor for producing goods and services. Similarly, when skilled labor is available to produce goods and services, then only the organization would invest capital for production purpose.
In such a case, land and capital are complementary to each other. On the other hand, if an organization has enough capital to purchase advance technology, then it would prefer to reduce the number of labor. However, if the organization has shortage of capital, then it would use more labor instead of investing on advance technology and machines. In such a case, capital and labor act as substitute of each other.
In literary sense, land is regarded as soil. However, in economics, land, a factor of production, has a much wider scope. Marshall has defined land as, “the materials and the forces which nature gives freely for man’s aid, in land and water, in air and light and heat.” Land refers to a natural resource that can be utilized to produce income. It is a useful factor of production, but is available in limited quantity.
Certain facts about land are as follows:
i. Perceived as a gift of nature to man.
ii. Considered to be available in fixed quantity; therefore, does not have a supply price. This implies that the change in price of land does not affect its supply.
iii. Regarded as a permanent input having certain inherent properties, which are original and indestructible.
iv. Considered as an immobile factor of production.
v. Considered to have infinite variation in terms of fertility. This leads to variation in the prices of land.
Labor constitutes one of the important factors of production. This factor involves human services and efforts for the production of goods or services. Labor is commonly thought of a group of unskilled labor working in factories. However, in economic terms, a work, physical or mental, carried out for monetary purpose is called labor.
A work that is undertaken by an individual for the sake of interest and pleasure, then the individual would not be regarded as labor in economics. According to Marshall, “Any exertion of mind or body undergone partly or wholly with a view to some good other than the pleasure derived directly from the work is called labor.”
Among all the factors of production, labor is the only factor that is living. This peculiarity of labor differentiates it from rest of the factors of production.
Some of the peculiarities of labor are as follows:
i. Labor cannot be separated from laborer. This is because laborer needs to sell his/her labor.
ii. Labor is defined as the perishable factor of production that has no reserve price.
iii. Labor is considered as the weakest commodity in terms of bargaining power.
iv. Change in the price of labor would affect the supply of labor. In case of other commodities, supply rises with the rise in prices. In case of labor, supply of labor decreases with an increase in prices (wages) and vice versa. For example, if the wage of a worker reduces, then other family members of worker start working to meet up the requirements of their family.
v. Adjustments in supply and demand of labor is difficult because it is difficult to increase or decrease labor instantly.
Production is organized on the basis of division of labor. Let us discuss about division of labor in detail.
Division of Labor:
Adam Smith- the father of economics laid a greater emphasis on the concept of division of labor in his book, “An Inquiry into the Mature and Causes of the Wealth of Nations” in 1776. He stated that division of labor plays a vital role in increasing the productivity of labor. According to him, division of labor is the dynamic instrument for economic growth and development.
For explaining the importance of division of labor, he cited an example of pin making in an organization. The pin making function of an organization involves 18 processes. If these 18 processes are performed by a single worker, it would not be possible to complete the whole function or it may take much time to produce a single pin. Therefore, if these tasks are divided among a number of workers, then it would be easier to produce large number of pins in a day.
According to Stingier, “the division of labor is not a quaint practice of eighteenth century pin factories; it is a fundamental principle of economic organization.” Therefore, division of labor is useful to an organization in many ways.
There are different types of division of labor, which are explained as follows:
i. Simple Division of Labor:
Refers to the division of labor on the basis of their skills and occupations, such as carpenters and blacksmith. It is also referred as functional division of labor.
ii. Complex Division of Labor:
Refers to the division of labor on the basis of business processes and sub-processes. For example, most of the organizations have different names for their processes, such as marketing process, manufacturing process, and distribution process. These processes are delegated to different groups of labor depending on their skills and abilities.
iii. Territorial Division of Labor:
Refers to the division of labor on the basis of geographical locations. In this type of division of labor, the processes are performed by specific cities or towns that are specialized in it. For example, in India, Kashmir is famous for its carpets and shawls, whereas Punjab is popular for agriculture.
Advantages and Disadvantages of Division of Labor:
Division of labor is useful for an organization in many ways.
Some of the advantages of division of labor are as follows:
i. Increasing Productivity:
Refers to one of the main advantage of division of labor. Some processes of an organization are so long, thus, cannot be completed by a single worker or he/she would require more time to complete those processes. Consequently, the productivity of the organization would be affected. If the process is divided among a number of workers, they would be able to perform it efficiency and in less duration of time.
While explaining the importance of division of labor with respect to productivity, Adam Smith has used an example of manufacturing of a pin. There are 18 processes require to manufacture a single pin. In a day, ten workers can make 48,000 pins. This is possible if those 18 processes delegated among a number of workers. Otherwise, it is hard to make a single pin by one worker performing all the 18 processes.
ii. Increasing Dexterity and Skills:
Implies that repetitive working on the same process makes workers expert of that process, which leads to reduction in errors.
iii. Facilitating Inventions:
Implies that division of labor leads to innovation of new ideas because the work becomes mechanical rather than mental. Therefore, workers can freely think and generate innovative ideas.
iv. Saving Time:
Brings positive impact on the functioning of an organization. If tasks are specified, workers need to perform the same task again and again, which make them efficient in that particular task. This ultimately results in reducing time.
v. Increasing Employment Opportunities:
Implies that if workers are divided as per their skills and efficiency to perform different tasks, this would lead to an increase in the number of jobs.
vi. Encouraging Large-scale Production:
Implies that division of labor helps in increasing the quality and quantity of product. This motivates producers to increase the level of production.
However, division of labor is not free from disadvantages. Some of its disadvantages are as follows:
Implies that performing the same task again and again makes the work less interesting, which results in decrease in the motivation level of workers. This further affects the productivity of labor.
ii. Human Development:
Refers to the fact that job affects the mental and physical growth of an individual. A monotonous work makes the individual think in the same direction. This may discourage individuals to think freely and generate ideas.
iii. Loss of Skills:
Refers to one of the major adverse effects of division of labor. By division, labor gets specialized in making only a part of the process and not the whole process; therefore, loses the skill to make the whole product.
iv. Personal Life:
Implies that increase in number of employment opportunities through division of labor also involve the employment of women and children. Involvement of women affects their personal lives and employment of children causes deterioration of their future.
v. Evils of Industrialization:
Refers to the fact that division of labor leads to establishment of more and more industries. This may result in imbalance of environment and create a number of problems, such as air pollution, water pollution, and global warming.
In general terms, capital refers to the part of an individual’s income that is used for Income creation purposes. Capital is not considered as original factor of production. In economics, the term capital is associated with capital goods, such as plant, raw materials, fuel, and machinery. Among capital goods, raw material and goods under process are temporary because these goods are repurchased after a period of time.
However, plant and machinery are goods that are permanent and are purchased only once. Apart from this, land cannot be regarded as capital because of the dissimilarities between the characteristics of land and capital. For example, land is natural, permanent, immobile, and fixed. On the other hand, capital is manmade, temporary, mobile, and differs from time to time.
However, capital is one of the important factors as production of any kind of goods and services is dependent on capital. Production cannot take place without the involvement of capital. An organization requires a number of capital goods, such as tools and machinery, to produce goods.
Moreover, capital also plays a major role in economic development by raising productivity. Therefore, a nation should have an adequate amount of capital to invest in various economic development projects, such as construction and renovation of infrastructure. This would help in generating employment opportunities and raising the standard of living.
Apart from this, capital also marks a greater significance in the lives of individuals to fulfill their different needs. An individual can accumulate capital by compromising his/her current needs and saving for future. Therefore, saving is necessary for capital formation. Savings are not able to generate capital automatically; an individual needs to invest his/her savings for the generation of capital goods.
An enterprise is an entity, organization, or undertaking that is created for commercial purposes or business ventures and requires efforts. It is focused on providing goods and services keeping in view various aspects, such as financial, commercial, and industrial. An enterprise is composed of individuals and physical assets with a common goal of generating profits.
According to Micro, Small, and Medium Enterprises Development (MSMED) Act, 2006 “Enterprise means an industrial undertaking or a business concern or any other establishment, by whatever name called, engaged in the manufacture or production of goods, in any manner, pertaining to any industry specified in the First Schedule to the Industries (Development and Regulation) Act, 1951 or engaged in providing or rendering of any service or services.”
An individual, who creates an enterprise is called entrepreneur. The success or failure of an enterprise depends on the efficiency of the entrepreneur. An entrepreneur needs to be focused on adapting himself/herself according to the changes taking place in the national economy, industries, and markets. In addition, he/she should strive to invent new products and services or bring innovation in the existing products and introduce them in the market.
Apart from this, he/she should also make the optimal use of various resources, such as man, material, and machine. An entrepreneur should be ready to bear risks and uncertainties involved in the business. The formulation of an effective business plan and sound execution help an entrepreneur to maximize the chances of success.
According to J. A. Schumpeter, a German economist, an entrepreneur has the power to change the way an economy is moving. He also advocated that an entrepreneur is the person who combines production factors to make the production process efficient. According to him, an entrepreneur is a foresighted person having a risk taking and innovation capability.
The innovation can be in following five fields:
i. New product
ii. New machine
iii. New source of raw material supply
iv. New market
Scientific methods of organization:
Economist Joseph Schumpeter has given a significant contribution in understanding the concept of entrepreneurship. According to him, “An entrepreneur is a person who is willing and able to convert a new idea or invention into a successful innovation.” In the view of Schumpeter an entrepreneur employs “the gale of creative destruction.”
Creative destruction can be defined as the process of creating new product, business model, or other business innovations by replacing the old ones. Thus, new products and technologies developed by entrepreneurs over time make current products and technologies obsolete. For example, before the advent of mobile phones, pagers were very popular among people, but with the invention of mobile phones, pagers became obsolete.
Therefore, Schumpeter held the argument that creative destruction is the main factor behind economic growth and industry dynamism. He also held a view that entrepreneurship results not only in new industries, but also in new combinations of currently existing inputs.
Schumpeter exemplified this concept with the invention of a steam engine, which was used to develop a horseless carriage. Further, the horseless carriage was transformed into a car. This formation of car from steam engine was not the development of a new technology, but the application of existing technologies in a novel manner.
Definition of an Entrepreneur:
An entrepreneur is an individual, who establishes an enterprise. The word entrepreneur has been derived from a French word enterprendre, which means to undertake. An entrepreneur is a person, who undertakes risks, mobilizes resources, and generates employment by establishing and running an enterprise.
Some of the entrepreneurship experts have given the following definitions of entrepreneurship:
According to Encyclopedia Americana (1988), “An entrepreneur is a businessman who assumes the risk of bringing together the means of production including capital, labor and material and receives his reward in profit from the market value of his product”.
According to Schumpeter, “An entrepreneur characteristically innovates, introduces new technologies, increases efficiency, productivity, or generates new products or services. An entrepreneur acts as a catalyst for economic change and research indicates that entrepreneurs are highly creative individuals who imagine new solutions by generating opportunities-for profit or reward.”
In the words of Peter F. Drucker, “An entrepreneur searches for change, responds to it and exploits opportunities. Innovation is the specific tool of an entrepreneur.”
In the words of Richard Cantillion, “An entrepreneur is the agent who buys means of production at a certain price in order to combine them into a product that is going to sell at prices that are certain at the moment at which he commits himself to his costs.”
According to International Labor Organization, “Entrepreneurs are people who have the ability to see and evaluate business opportunities together with the necessary resources to take advantages of them and to intimate appropriate action to ensure success.”
According to Kirzner (1979), an entrepreneur is the arbitrageur, who buys a product in lower price and sells the same product in higher price to earn profit.
Traits and Characteristics of a Successful Entrepreneur:
The success or failure of an enterprise depends on the efficiency of an entrepreneur. An entrepreneur undertakes various activities, such as formulating and implementing a business plan and managing resources, to establish and run his/her enterprise successfully. He/she should possess some abilities and skills to perform different activities successfully.
Following are certain traits and characteristics of a successful entrepreneur:
Refers to the ability of an entrepreneur to bring out new ways to run a business. An entrepreneur needs to verify the feasibility of the new idea before implementing it. Creativity and innovation are always used interchangeably, but there is a huge difference between both of these two words. Creativity is bringing something new into existence, whereas innovation is doing new things. Therefore, creativity is a prerequisite for innovation.
Refers to the ability of an entrepreneur to provide things in a novel manner. It is a specific instrument of entrepreneurship to add value to products or services or the unique recombination of resources to give something new to the world. The market is never saturated for an entrepreneur.
For example, replacing fruits with soft drinks is not merely an innovative activity. It can be a new method of decreasing the cost of production, improving the design of the product, and increasing the market share by beating the competitors. Innovation is the result of continuous generation of new thoughts and ideas.
Refers to one of the important characteristics of an entrepreneur. A successful entrepreneur should strive to bring dynamism to industries and markets. He/she should be able to convert a new idea into a successful innovation. He/she should replace inferior innovations across markets and industries with new products.
iv. Risk Taking and Decision Making Ability:
Refers to the capability of entrepreneurs to make decisions under the conditions of uncertainty. They should have courage to put everything on stake to convert his/her idea into a reality. However, he/she should assess risks involved in the decision and estimate the probability of success before acting upon.
Implies that an entrepreneur can be successful if he/she is guided by inner self and motivated to accomplish set goals. In addition, an entrepreneur should take initiative to do something beyond their job requirement or the demand of the situation. He/she should also look for opportunities and take necessary actions to avail them.
Refers to one of the most required attributes in an entrepreneur that brings success in everything they do. An entrepreneur has a strong belief in self and own abilities. They express confidence in completing any task or meeting any challenge. They stick to the judgment in the face of opposition or early lack of success. They feel confident enough to take new challenges.
vii. Time Management:
Refers the skill of an entrepreneur to manage time effectively and efficiently. He/she should strive to work within the allotted time or before that, and utilize rest of time in learning more skills.
Implies that an entrepreneur should keep putting repetitive efforts or different actions to get over the obstacles. He/she should not be discouraged by the initial failure or obstacle that they get in the way of reaching goals.
ix. Problem Solving:
Indicates the ability of an entrepreneur to solve problems rather than avoiding them. An entrepreneur should identify the cause of problems that come in the way and searches potentially unique ideas to solve them. He/she should either switch to an alternative strategy to reach a goal or generate innovative solutions.
Helps an entrepreneur to adapt to the changing marketplace, strategies of competitors, and preferences of customers. It also helps the entrepreneur to make necessary changes in his/her products and services as per the market conditions.
Refers to the characteristic of an entrepreneur to visualize the way to successfully complete tasks to achieve set goals and objectives. In addition, the entrepreneur should communicate his/her with all shareholders of the enterprise, which, in turn, motivates them to achieve the set goals.
Refers to one of the most indispensable quality of an entrepreneur that decides the success of the organization. The leadership spirit helps the entrepreneur to move forward in every sphere of his/her life. The entrepreneur should be able to handle the problem effectively, generating resources, and influence others to perform efficiently.
xiii. Technical Knowledge:
Implies that an entrepreneur should be able to understand all the technical aspects, such as systems, procedures, and methodology, used in production. Additionally, he/she should need to develop technical skills to understand, communicate, and lead the technical staff of the enterprise.
Functions of an Entrepreneur:
An entrepreneur takes the risk and organizes resources to establish and operate his/her enterprise. He/she identifies and traps the existing opportunities in the market, converts idea into action, bears the risk and uncertainties involved, and takes promotional activities to launch the enterprise. In addition, they strive for excellence in their field.
Some of the functions of an entrepreneur are described as follows:
i. Idea Generation:
Implies that an entrepreneur identifies business opportunities, selects the most suitable business opportunity, and converts that opportunity/idea into a successful business venture.
Indicates that in today’s time the activities of entrepreneurs are not only limited to establish an enterprise. Nowadays, entrepreneurs are also involved in various other activities, such as promoting for setting up a new enterprise, attracting the investors, expanding the existing enterprise, and combining two or more enterprises. As a promoter, an entrepreneur conducts feasibility studies, decides the form of organization, assembles the required resources, such as capital and human resource, and shapes up the enterprise.
iii. Risk and Uncertainty Bearing:
Implies that an enterprise needs to bear risks involved in establishing a new enterprise or starting a new business venture. He/she should be ready to bear the losses that may arise because of unforeseen situations in future. He/she does not hesitate in doing new things and adopting new methods of production.
iv. Arranging Finance:
Indicates that entrepreneurs arrange finance for setting up the enterprise. An entrepreneur is an individual, who provides initial capital to start the venture and arranges additional funds required to carry on activities and expand the business.
Signifies that an entrepreneur needs to employ individuals with the required skill-sets for operating in the different functions of the organizations.