FACTORS OF PRODUCTION

MEANING :  It refers to inputs. Let us understand what we mean by inputs. An input is a good or service which a firm buys for its use in its production process. Production process consists of various processes such as Changing in the form of natural resources ( eg. changing the form of log of wood into a table),  changing the place of natural resources ( eg. extraction of coal, gold mines from earth, transporting apples from where they are less in demand to places where they are high in demand). making available materials at times when they are not normally available ( eg. canning of fruits) and making use of skills in the form of services( for eg. services of organizers, merchants). A good has to go through many stages and many hands until it reaches the consumer’s hands in a finished form.

Following are the four factors or resources which make it possible to produce goods or services:

1. Land
2. Labor
3. Capital
4. Entrepreneur

Note: Land is a free gift of nature and termed as natural resources. However human endeavor is classified functionally and quantitatively into three main components namely, Labor, Capital, Entrepreneur. 

Let us understand each of these factors of production: 

Land: 

MEANING: When we talk of land it does not mean soil or earths surface alone. It includes all free gifts of nature which not only includes land but also all free gifts of nature which include:

• Natural resources
• Fertility of soil
• Water
• Heat
• Light
• Natural vegetation etc. 

Therefore at times it becomes difficult to distinguish between the free gift of nature and those because of human effort in the past. 

FOLLOWING ARE THE CHARACTERISTICS OF LAND:

• Land is free gift of nature
• Supply of land is fixed
• Land is permanent and has indestructible powers
• Land is a passive factor
• Land is immobile
• Land has multiple uses
• Land is heterogeneous

Each of this point is explained in detail below:

Land is a free gift of nature: As there is no human effort involved in making land available. Land has no supply price also as no payment has to be done to mother nature in order to obtain land. 

Supply of land is fixed: land is limited in quantity. No change in demand can affect the amount of land in existence.

Land is permanent and has indestructible powers: land cannot be destroyed as such and hence it has indestructible powers and it is permanent as it cannot be destroyed. According to Ricardo, land has certain original and indestructible powers and cannot be destroyed. 

Land is a passive factor: land is not an active factor. Unless human effort is exercised on land it can not produce. Land cannot produce anything on its own.

Land is immobile: one cannot shift land from one place to another. Geographically it is not possible. The natural factors can not be shifted to another place. Thus, in a geographical sense we can say land is immobile.

Land has multiple uses: Land can be used for varied purposes though its suitability in all the uses is not the same.

Land is heterogeneous: We know that no two pieces of land are the same. They differ in fertility and situation.

LABOR:

Meaning: Labor means any physical or mental exertion directed to produce goods or services. Labor requires all human effort of body or mind undergone wholly or partly with a view to secure an income apart from the pleasure derived directly from the work is termed as labor. For labor human effort in the form of physical exertion, skill and intellect is required. All 3 aspects are usually a must in labor though their proportions may vary. It is very important to note that in economics labor is only the one which earns reward and not one which is done out of love and affection. 

CHARACTERISTICS OF LABOR:

• Human effort
• Labor is perishable
• Labor is an active factor
• Labor is inseparable from the laborers
• Labor power differs from one laborer to another
• All labor may not be productive
• Labor has poor bargaining power
• Labor is mobile
• There is no rapid adjustment of supply of  labor to the demand of it
• Choice between hours of labor and hours of leisure

Human effort: labor is different as compared to other factors of production. Labor requires human effort. Thus there are human and psychological considerations which come up in labor as compared to other factors of production. Therefore, leisure, fair treatment, and a favorable work environment are required for laborers.

Labor is perishable: As we know a laborer can not store his work so a day of labor lost can not be completely recovered the other day by working additional time.

Labor is an active factor: Without labor , land and capital can not produce anything.

Labor is inseparable from the laborers: A laborer is the source of his own labor power.Although a laborer sells his services but he needs to be physically present in order to get the work done. A laborer sells his services against wages but retains the capacity to work.

Labor power differs from one laborer to another: Each human is different and hence his or her effort or say efficiency would also be different. Labor power efficiency depends upon inherent and acquired qualities, characteristics of the work environment, incentive to work,etc.

All labor may not be productive: All efforts are not sure to produce the same resources or efficiency.

Labor has poor bargaining power: Labor cannot be stored and thus, the laborer is compelled to work at the wages offered by the employers. Thus, they can be exploited and forced to work more. Hence proved labor has poor bargaining power. Labor is economically weak and the employer is economically strong. However, things are changing now with greater awareness.

Labor is mobile: In the sense the laborers can easily move from place to another ie to say from one job to another. But changing jobs is practically difficult as many obstacles arise.

There is no rapid adjustment of supply of  labor to the demand of it: The total supply of labor can not be increased or decreased instantly.

Choice between hours of labor and hours of leisure: There is a  direct relationship between labor and Wage rate. As the  wage rate Increases the laborer tries to increase the supply of labor. Increased supply of labor means reduced time of leisure. However, beyond a certain level of income, the laborer reduces the supply of labor and increases the hours of leisure in response to further rise in wage rate. He prefers to have more hours of rest and leisure as compared to earning more money. 

CAPITAL:

MEANING OF CAPITAL: Capital is a stock concept which yields a periodical income which is a flow concept. It is that part of wealth for an individual or community which is used for further production of wealth. However, it is very important to distinguish between wealth and capital. Wealth refers to all those goods and human qualities which are useful in production and can be passed on for value. If these resources are lying idle they would constitute wealth and not capital. 

DEFINITION OF CAPITAL: Capital can be defined as ‘ produced means of production’ or’ man made instruments of production’. In other words, capital goods refers to all man made goods that are used for further production of wealth. Thus capital distinguishes itself from land and labor.land and labor are factors of production whereas capital is not a factor of production. Land and labor are primary or original factors of production but capital is not the primary or original factor of production it is a produced factor of production. It is produced by man by working with nature. Capital is produced by man to help in the production of further goods.

EXAMPLES:

TYPES OF CAPITAL:

Fixed Capital: Is that part of capital which exists in a durable shape and renders a series of services over a period of time. For eg: tools, machines, etc.

Circulating Capital: Is a form of capital which performs its function in production in a single use only and is not available for further use. For eg: seeds, fuel, raw materials, etc.

Real Capital: It refers to physical goods. For eg: building, plant, machines, etc.

Human Capital: As a great deal of investment goes into creation of abilities in humans it is called human capital. It refers to human skill and ability.

Tangible Capital and Intangible Capital: Tangible Capital is one which can be perceived by senses for eg: building, land. Whereas Intangible Capital is one which can not be perceived by senses. For eg: goodwill, copyrights, patents, etc.

Individual Capital: Is the personal property owned by an individual or community. For eg: talent.

Social Capital: Is that capital which belongs to the society as a whole. For eg: roads, bridges, etc. 

CAPITAL FORMATION: 

MEANING: It refers to sustained increase in the stock of real capital in accounting. It involves production of more capital goods like machines, tools, factories, transport equipment, electricity, etc. which are used for further production of goods. It is also known as investment.

NEED: The need for capital formation is not limited to replacement and renovation but for creating productive capacity. In order to accumulate some capital goods some current consumption needs to be sacrificed and savings of current income are to be made. The savings also need to be channeled into productive investment. The greater the ability of the people to abstain from current consumption the greater will be the savings and investment that the society will devote to capital formation. If consumption is equal to production then there will be no savings and the productive capacity of the economy will fall when the present capital equipment wears out. If the whole of the current present capacity is used to produce consumer goods and no new capital goods are made the production of consumer goods in future will greatly decline. It is prudent to cut down on some of the present consumption and direct a part of it to the making of capital goods such as tools and instruments, machines and transport facilities, plant and equipments, etc. higher rate of capital formation will enhance production and increase the efficacy  of production efforts, accelerate economic growth and add to opportunities for management.

STAGES OF CAPITAL FORMATION: There are mainly three stages of capital formation. They are as below:

1. Savings
2. Mobilization of savings
3. investment

Each one of these are explained in detail as follows:

• Savings: The basic factor on which formation of capital depends is the ability to save.The ability to save depends upon the income of an individual. Higher the income, higher would be the savings. With higher income the propensity to consume decreases and the ability to save increases. This is true not only in the case of an individual but for the economy as a whole. A rich country has a greater ability to save and thus becomes richer quicker. Whereas a poor country has no ability to save and thereby leading to limited growth in national income, given the capital input – output ratio. The important point to be noted is that it is not only the ability but also the willingness to save is required. If an individual is far sighted and has the willingness to secure his future will save more. The government can enforce compulsory savings on employed people by making insurance and provident fund compulsory. Government can also encourage savings by allowing tax deductions on income saved. In recent years, business community savings and government savings are also becoming important.
• Mobilization of Savings: It is not enough to save money. The saved money should enter into circulation and facilitate the process of capital formation. One of the preconditions of capital formation is the availability of financial products and institutions. There should be a widespread network of banking and other financial institutions to collect public savings and take them to prospective buyers. The state has a very positive or important role to play both in generating savings through various fiscal and monetary incentives and in channelising the savings towards priority needs of the society so that there is not only capital generation but also socially beneficial type of capital formation.
• Investment: The process of capital formation gets completed only when the  real savings get converted into real capital assets. An economy should have an entrepreneurial class which is ready to bear the risk of business and invest savings in productive avenues so as to create new capital assets.

ENTREPRENEUR: 

After studying the three factors of production land, labor and capital. Let us understand the fourth factor of a production  entrepreneur in detail. 

MEANING: Though land, labor , capital are the factors of production, it is the entrepreneur who mobilizes these factors, combines them in the right proportion, initiates the process of production and bears the risk involved in it. This factor is known as the  entrepreneur.

FUNCTIONS OF AN ENTREPRENEUR: The following are the functions of an entrepreneur:

• Initiating business enterprise and resource coordination
• Risk bearing or uncertainty bearing
• Innovations

Let us understand each one of these points in detail:

Initiating business enterprise and resource coordination: The first and foremost function of an entrepreneur is to initiate a business enterprise. Now the question arises is how? An entrepreneur perceives an opportunity , organizes his resources needed to exploit that opportunity and then exploits it. He undertakes the dynamic process of obtaining different factors of production ( land, labor, capital) and bringing about coordination among them and using these economic resources to secure higher productivity and greater yield. An entrepreneur hires the services of various other factors of production and pays them fixed contractual rewards.

The surplus if any, after paying for all factors of production hired by him accrues to the entrepreneur as a reward for his efforts and risk taking. Thus, the reward for an entrepreneur is not fixed or certain. Other factors of production i.e. land, labor and capital get payment irrespective of whether the entrepreneur makes profit or loss. Thus, we can say an entrepreneur senses business opportunities , conceives projects.

Risk bearing or uncertainty bearing: The ultimate responsibility for the success and survival of business lies with the entrepreneur. Actual course may be different from what is planned and anticipated . The economy is dynamic and changes occur everyday. The demand for a commodity, cost structure, fashions and taste and preferences of the people and government’s policy regarding taxation, credit rate, interest etc may change. All these changes are not anticipated by the  entrepreneur and as a result he may incur loss. Apart from these financial risks an  entrepreneur also faces technological risks which arise due to changes in technology as inventions and improvements in technology makes the existing techniques and machines obsolete. The  entrepreneur has to access and bear the risks. However, Frank Knight is of the opinion that profit is the reward for bearing uncertainties. However, an  entrepreneur has to not bear foreseeable risks such as fire, theft, burglary, etc. as these are insured. Important point to note is that uncertainties are different from risks in the sense that these can not be insured against and therefore the  entrepreneur has to bear them. For eg. genuine business uncertainties such as change in taste, emergence of competition, etc. can not be foreseen or insured against. Risk bearing is the most important function of an  entrepreneur as nearly all other functions of an  entrepreneur can be delegated or entrusted with paid managers, risk bearing can not be delegated to anyone.

Innovations: Refer to commercial application of new ideas or inventions to better fulfillment of business requirements. Innovations in a broad sense include the introduction of new or improved products, devices and production processes, utilization of new or improved sources of raw material, adoption of new or improved technology, novel business models, extending sales to unexplored markets, etc. According to Schumpter, the task of an entrepreneur is to continuously introduce new innovations. Innovations may bring greater efficiency and competitiveness in business and bring profits to the innovator. A successful innovation is imitated by others in due course of time. An innovation may yield profits for the entrepreneur for a short period of time but when it is widely adopted by others the profits tend to disappear. The entrepreneurs promote economic growth of the country by introducing new innovations from time to time and contributing to technological progress. But innovations involve risk and only a few people in this society are capable of introducing new innovations. The true function of an entrepreneur is to introduce innovations according to Schumpter. The greater the innovating ability, the greater will be the supply of entrepreneurs and greater will be the state of technological progress.

ENTERPRISE OBJECTIVES: The standard assumption of any enterprise is that business activity is carried out with the sole objective of earning profits. However, in the real world entrepreneurs do not make profits solely on the basis of profit maximization objectives. Since an enterprise functions in an economic, political, social, cultural environment its objectives need to be set up in relation to its survival and growth in such environment.Thus, the objectives of an enterprise may be broadly classified as under:

• Organic Objective
• Economic Objective
• Social Objective
• Human Objective
• National Objective

Organic Objective : The basic minimum objective of an enterprise is to survive or stay alive. However an enterprise can survive only if it’s able to at least recover its costs. In case the enterprise does not recover its costs of staying in the business it will not be in a position to meet its obligations to its creditors, suppliers and employees as a result there may be forced bankruptcy. Therefore, survival of an enterprise is essential for the continuance of its business activities. Once the enterprise is assured of its survival then it will aim at growth and expansion. Nowadays with the rise of professional managers growth as an objective has started gaining importance. RL Marris’s theory of firm assumes that the goal of the managers of the corporate firms is to maximize the balanced growth rate subject to managerial and financial constraints. In the corporate world the structural division of ownership and management yields opportunities for managers to set goals which may not conform to the utility function of owner shareholders. The ability or success of the managers is judged by their performance in promoting the growth or expansion of the firm and rewards obtained by them are a reflection of the success of the firms in achieving growth of the firm managed by them. While owners want to utilize their utility function which relates to profit, capital, market share and reputation, managers want to utilize their utility function which includes variables such as power, salary, status and job security. Although there is a divergence and some degree of conflict between these utility functions, Marris argues that most of the variables incorporated in both of them are positively related to the size of the firm and therefore the two utility functions converge into a single variable namely, a steady growth in the size of the firms. The managers do not aim at optimizing profits rather they aim at optimization of the balanced rate of growth of the firm which involves optimization of the rate of increase in demand of the commodities of the firm and the rate of increase of capital supply.

Economic Objective:  The profit maximizing behavior of the firm has been the most basic assumption made by economists in the past and is still at the heart of the neoclassical microeconomic theory. This assumption is simple, rational and quantitative and is amenable to equilibrium analysis. Under this assumption, firms decide the price and output  policy in such a way as to maximize profits within constraints such as technology, finance, etc. Investors expect that their company will earn sufficient profits to ensure fair returns to them and improve their stock prices. Creditors will be reluctant to lend money to an enterprise which is not making profits. Any increase in salaries, wages, and perquisites of employees can come only out of profits. Though profit is calculated as per Total Costs – Total Revenue. But there is a huge difference between Economic profits and accounting profits. The difference lies in costs. Accounting costs considers only explicit costs whereas economic costs includes both explicit as well as implicit costs ie. The cost of self employed factors used by the entrepreneur in his own business. Hence, economic profit is generally less than accounting profits as economic profits includes the opportunity costs associated with self owned factors. When the economists speaks of profits he or she means profit after taking into account the capital and labor provided by the owners ie. They differentiate between normal profits and supernormal profits. Normal profits include normal rate of return on capital invested by the entrepreneur, remuneration of the labor and the risk bearing function of the entrepreneur. Let us understand the difference between normal profit and super normal profit. Normal profit or zero economic profit is a component of cost and therefore whatever a business owner owns is considered the minimum necessary to continue in the business. Super profit or economic profit or abnormal profit is over and above normal profits. It is earned when total revenue is greater than total costs. Total costs in this case includes rewards to all factors including normal profit.

Profit maximization objective has been subject to criticism in recent years. Some firms try to achieve security subject to a reasonable level of profits. Therefore, many economists have pointed out that all firms do not aim to maximize profits. HA Simon argues that firms have ‘satisficing’ behavior and strive for profits that are satisfactory. Baumol’s theory of sales maximization holds that sales revenue maximization rather than profit maximization is the ultimate goal of the business. He cites empirical evidence for his hypothesis that sales rank ahead of profits. Whenever you ask an executive about his business, the answer would be sales are increasing or decreasing and profit is only an afterthought. He however points out that in their attempt to maximize sales, businessmen do not completely ignore the costs incurred on the outputs and the profits to be made. 1932, AA Berle and GC Means pointed out that in large business corporations, management is separate from ownership and therefore managers enjoy discretionary powers to set goals of the firm they manage. Williamson’s model of maximization of managerial utility function is an important contribution to managerial theory of firm’s behavior. The owners ie. the shareholders of joint stock companies prefer profit maximization but managers maximize their own utility function subject to minimum profit rather than profit maximization. The objective of utility maximization has been discussed in the context of two types of firms first, in case of firms owned and managed by the entrepreneur himself. Utility maximization implies that while choosing an output level, the entrepreneur ie. The owner himself considers not only the money profits which he will make but also the sacrifice of leisure which he would make in doing necessary activity for producing a level of output. Secondly in case of large joint stock companies the utility function of managers or executives of these companies include not only profits which they earn for shareholders but also:

• Promotion of sales
• Maintaining lavish offices
• Seeking to have a large number of staff under their supervision, etc.

In this case the manager will maximize his utility by  attaining a best combination of profits and the above mentioned other objectives.

Cyert and March suggests four possible functional goals in addition to profit goal:

1. Production goal
2. Inventory goal
3. Sales goal
4. Market share goal

Social Objective: Enterprise lives in a society. It can not grow unless it meets the needs of the society. Some important social objectives of a business are:

• Maintain a continuous and sufficient supply of unadulterated goods and articles of standard quality. 
• To avoid profiteering and anti-social practices 
• To create opportunities for gainful employment for the people in the society.
• To ensure that enterprises output does not cause any type of pollution like air, water or noise.

An enterprise should continuously endeavor to contribute to the quality of life of its community in particular and society in general. If it fails to do so it may not survive for long. 

Human: Human beings are the most precious resources of an organization. If ignored, it will be difficult for an enterprise to achieve any of its other objectives. Therefore comprehensive development of its human resources or employees should be one of the major objectives of an organization.

Some of the important human objectives are:

• To provide fair deals to the employees at different levels.
• To develop new skills and abilities and develop a work climate in which they will grow as mature and productive individuals.
• To provide the employees an opportunity to participate in decision-making in matters affecting them.
• To make job contents interesting and challenging.

If the enterprise is conscious of its duties towards its employees, it will be able to secure their loyalty and support.

National Objective:  An enterprise should endeavor for fulfillment of its national needs and aspirations and work towards implementation of national plans and policies. Some of the national objectives are:

• To remove inequality of opportunities and provide fair opportunity to all work and to progress.
• To produce according to national priorities
• To help the country to become self reliant and avoid dependence on other nations.
• To train young men as apprentices and thus contribute in skill formation for economic growth and development.

Important points to remember:

• All enterprises have multiple goals, they need to set priorities. This requires appropriate balancing of the objectives in order to determine the relative importance of each.
• Objectives may conflict with each other. Eg. profit maximization objective may not be wholly consistent with the marketing objective of increasing its marketing share which may involve:

• Similarly its social responsibility objective may run into conflict with the introduction of technological changes which may cause unemployment or environmental pollution. Manager has also to strike a balance between the two so that both can be met with reasonable success.
• The basic assumption is that firms aim to maximize profits unless otherwise mentioned.
• In pursuit of this objective an enterprise’s actions may get constrained by many factors. Important among these are:

• Lack of information and knowledge: enterprise functions in an uncertain world due to which many other variables that affect the performance of the firm can not be correctly predicted for the current month or year and left alone for future. Firms may not know the prices of all inputs and characteristics of relevant technologies making it difficult to determine what the profit maximizing price is.
• There may be other constraints such as restrictions imposed in the public interest in the state on the production, price and movement of factors. In practice, there are several hurdles for free mobility of labor and capital. For eg. Trade unions may place several restrictions on the mobility of labor or specialized training may be required to enable workers to change occupations. These contingencies make profit attainment a difficult task.
• There may be infrastructural inadequacies thus resulity in supply chain bottlenecks and subsequently resulting in shortages and unexpected emergencies. For eg. frequent power cuts, irregular supply of raw materials or non availability of transport . thereby putting limitations on the profit maximization objective of the enterprise.
• Changes in business and economic conditions which become contagious due to the highly connected nature of economies, place constraints by causing demand fluctuations and instability in firms sales and revenues. Also external factors such as: sudden change in government policies with regard to location, prices, taxes, production, etc. or natural calamities such as flood, fire, theft etc. may place additional burdens on the business firms and defeat their plans. When firms are forced to implement policies in response to fiscal limitations, legal, regulatory or contractual requirements, these have adverse consequences on the firms profitability and growth plans.
• Events such as inflation, rising interest rates, unfavorable exchange rates , unfavorable exchange rate fluctuations cause an increase in the rise of raw material, labor, capital and affect the budget and financial plans of the firm. Even inability to find skilled force at competitive wage rate as well as constant training required to employees cause significant constraint to achieve the profit maximization objective.

Problems of an enterprise: an enterprise faces a number of problems right from its inception throughout its lifetime and till its closure. Some of the problems faced by an enterprise are as follows:

• Problems relating to objectives: An enterprise has to choose from various objectives is a problem in itself but striking a balance between the two is also difficult for an enterprise.
• Problems relating to location and size of plant: with regards to location of the plant an entrepreneur has to decide about the location of the plant should it be near the market or source of raw material. An entrepreneur has to consider other costs such as: cost of labor, facilities and cost of production too. An entrepreneur will have to weigh relevant factors against one another to choose the right location which is most close to the location. An entrepreneur needs to decide with regard to the size of the firm as well. He has to decide whether it has to be a small scale unit or large scale unit. Due consideration needs to be given to technical, managerial, marketing and financial aspects of the proposed business before deciding on the scale of operations. Management must make a realistic evaluation of its strength and weaknesses or limitations before choosing a particular size of new unit.
• Problems relating to selecting and organizing physical facilities: A firm has to make a decision on the nature of the production process to be employed and the type of equipment to be installed. The choice depends upon the design chosen and the required volume of production. Production on a large scale involves use of elaborate, specialized and complicated machine processes. Choice also depends upon the evaluation of their cost and efficiency. Once equipment to be used and the process to be employed is decided the entrepreneur will decide a layout illustrating the arrangement of equipment , buildings and allocation for each activity. 
• Problems relating to finance: Financial planning involves determination of the amount of funds required for the enterprise with reference to physical plans already prepared or planned,assessment of demand and cost of production for its products, estimation of profits on its investments , comparison of profits  with the existing concerns to find out whether the proposed investments will be profitable or not and determining capital structure and appropriate time for financing the enterprise etc. An entrepreneur has to undertake not only physical planning but also financial planning.
• Problems relating to organizational structure: It has to divide the total work of the enterprise into specialized functions and then constitute proper departments for each function. Functions for all positions and levels should be clearly laid down and their interrelationship in terms of: span of control, authority, responsibility, etc.
• Problems relating to marketing: Proper marketing of products and services is essential for growth and survival of enterprise. In order to achieve this the enterprise has to discover its target markets by identifying actual and potential customers and determining tactical marketing tools it can use to produce desired responses from its target markets. After indenting the markets the enterprise has to make decision regarding four P’S:

• Problems relating to legal formalities: A number of legal formalities have to be carried out at the time of launching, lifetime and closure of an enterprise. All these formalities are mostly related to taxes and law.
• Problems relating to industrial relations: with the emergence of the present day factory system of production management has to devise special measures to win the cooperation of the large number of workers employed in the industry. Misunderstanding and conflict of interests have assumed enormous dimensions that these can not be easily and promptly dealt with. Industrial relations at present are more involved and complicated. Various problems which an enterprise faces due to industrial relations are: Problems of winning workers cooperation, the problem of enforcing proper discipline among workers, the problem of dealing with organized labor and the problem of establishing a state of democracy in the industry by associating workers with the management of the industry.

Thanks for Learning, Always Welcome.