Factors of Production and Their Rewards

What are Factors of Production?

Factors of production are the resources used to produce goods and services in an economy. Economists group them into four main categories.

The Four Factors of Production

• Land: all natural resources used in production, such as soil, water, minerals, and forests. Its reward is rent.
• Labour: the human effort, both physical and mental, used in production. Its reward is wages/salary.
• Capital: man-made resources used to produce other goods, such as machinery, tools, and buildings. Its reward is interest.
• Entrepreneurship: the skill of organizing the other three factors, taking risks, and making business decisions. Its reward is profit.

Characteristics of Each Factor

Land is fixed in supply and cannot be increased. Labour varies in quality and quantity depending on skills, education and population. Capital can be increased through investment and savings. Entrepreneurship is the scarcest factor, since not everyone has the skill and willingness to take business risks.

Why Rewards Differ

Each factor earns a different type of reward because it plays a different role in production and bears a different level of risk — for example, the entrepreneur bears the risk of loss and so earns profit (which can be negative), while a worker is guaranteed wages regardless of whether the business makes a profit.

Importance of Understanding Factors of Production

Understanding the factors of production and their rewards helps explain how income is distributed in an economy, why businesses combine resources the way they do, and how the scarcity of land, capital, or entrepreneurial skill can limit a country's economic growth.