Why Are Factors of Production Important in Economics?

by Tom Lutzenberger; Updated September 26, 2017
Factories in the past and today are dependent on labor as one of the factors of production.

Economics studies the behavior of business as it affects an entire market and a nation. In this respect, certain production inputs must occur for outputs to be manufactured. From an economic sense, these inputs are catalysts; without them, businesses do not function or operate. Their genesis as concepts dates to Adam Smith’s description of business, "The Wealth of Nations," in 1776. It's important to remember, however, that factors of production are categories, and economics are driven by thousands of different variables and inputs. Thus categories are used to group similar inputs for the purposes of study.

Factors Defined

The first of the factors is land. In traditional business, a company can't operate without a production location. Furthermore, the type of land dictates the ability to find resources, move product and be protected. This factor doesn't apply so much today to businesses that function over the Internet, but even electronic commerce still needs a secure place to house its servers. Next comes labor. Human input is crucial for any tasks that require decision-making, and the bigger a business gets the more employees it needs. Third is capital. Investment and capital equipment are both necessary to ensure significant production. The fourth factor involves enterprise. This element represents the creative zeal of a company that allows it to produce goods or services people want. For example, much of Apple’s modern success is attributed to Steve Jobs' creativity in seeing new markets.

Importance of the Factors

From an economics perspective, every business must have the four elements in place for production to occur. There are no exceptions. Again, e-commerce seems to break this rule, not requiring a brick-and-mortar location. However, in reality even website-only businesses require their data to be saved somewhere on someone’s computer physically. Also, it’s not enough to have the four factors available; they must also be balanced. Too much labor and not enough space to house employees creates inefficiencies. Plenty of ideas and people but no capital investment means a business won’t be able to grow exponentially. Each element needs to match the demands of the other for the business to expand with profit.

Ongoing Maintenance

A business must also pay attention to keeping a supply of capital, labor, ideas and logistics available regularly. Many of the production factors are consumable. This means they have a finite life and get used up or committed to full capacity. To keep the business going as well as growing, more resources for production are needed. This aspect can limit a business from expanding into new markets while competitors race ahead and grab valuable customers.

Supply Matters

What doesn’t get mentioned about factors of production is that they have to come from somewhere. Economics treats this fact as another business transaction, but for a business, maintaining good supply streams is critical. Factors can't be guaranteed or maintained without a supplier to provide them. And, if a supplier chooses to stop providing, a business can be quickly cut off from the production factors it needs. Automakers are keenly aware of this dependence on their part suppliers, knowing a cutback could shut down an entire assembly line of a specific car model.

About the Author

Since 2009 Tom Lutzenberger has written for various websites, covering topics ranging from finance to automotive history. Lutzenberger works in public finance and policy and consults on a variety of analytical services. His education includes a Bachelor of Arts in English and political science from Saint Mary's College and a Master of Business Administration in finance and marketing from California State University, Sacramento.

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