Factors of production – definition

Factors of production are the resource inputs needed by producers in order to create an output of goods and services. Factors are the basic ‘building blocks’ of economic activity.

There are four basic factors, including land and natural resources, labour, capital and enterprise. Modern economists also refer to the environment as a fifth factor of production.

Factors are traded in factor markets, including the labour market, the capital market and the market for commercial property.

The role of the entrepreneur is to combine the other factors in the most efficient way.

When factors are used they earn a reward called a factor ‘income’. Factor incomes are: rent, wages, interest and profit.

In basic economic theory, the more scarce and essential the factor the greater the reward. Factors can be substituted when possible, and this affects the relative reward. The more a factor can be substituted the less it can exploit its relative scarcity. Production based on capital is called ‘capital intensive’ production, in contrast to ‘labour intensive’ production.