Why Are Factors of Production Important in Economics?

Economics embodies the concepts, theories and applications regarding individual and big-picture production, consumption and transfer of wealth. Since Adam Smith’s seminal “The Wealth of Nations” was published in 1776, essentially creating the concept of modern economics, “factors of production” have been divvied into four means of creating goods or services to generate an economic profit. As time moves on and technology shifts how we live and work, the importance of the factors of production evolve and adapt to modern society.

Besides these four factors of production, some believe the factors have begun to expand as a result of parameters including governance, trade barriers, technology and more. But, at their heart, each factor of production remains relevant to how the economy stays strong or why it falters. These factors are land, labor, capital and entrepreneurship.

As the 21st century moves ahead, there are aspects of modern society that people like Adam Smith, the godfather of economics, could never have foreseen. The use of robots in factories, for instance, and self-driving cars in transport will not only change efficiencies in production, but they will also put people out of work.

So economists now are studying ways in which society can balance technological advances while ensuring the populace still has money with which to live and spend. Ideally, the economy does not merely drive economic wealth — it must drive the distribution of wealth too.

Times have changed and it is now possible for a technology company to be born with zero investment in land, but land is still somewhat relevant. Historically, land was a pivotal factor because a company would need real estate for its operations and might even require land for the extraction or generation of natural resources. Regardless of what a company did, they would need an office, warehouse, factory or other place of doing business.

And then there were also the materials or products they may have sold, which would have ultimately come from the land — from wood to metal to food, it all came from the earth in some manner.

Land is important in production in several ways. Traditionally, one of the most expensive costs in doing business, whether it was through leasing a property or buying one. For things like agriculture, land has always been a critical aspect to production and economics, because so much can influence the land, like weather and pollution, pests and financial upheaval.

If a company loses access to a plot of land, it can change everything for them, because all land is not created equal. Take wine-making as an example; the specificity of land influences everything from production volume to the end results of flavor. Should a winemaker’s land be destroyed by fire or sold for another use, it could mean the end of availability of that particular varietal. If the costs associated with that land should skyrocket, then that too affects their business.

Even in the new era of technology, land still matters, though in a much more global sense. Borders mean different laws and logistics for rolling out digital and technological solutions and services. As an example, doing business with a service provider in China is dramatically more complicated than doing the same in the United States, therefore affecting a company's opportunities and profits.

In considering the importance of production in an economy, labor is huge, because it goes well beyond just the availability of workers: It is about the cost, the skill, the dedication, the innovation and so much more that people bring to the table. Labor has maintained its significance in the economy throughout history, up through today. And it is this persistent significance that drives the constant push to enhance labor or remove labor entirely via technological improvements.

People like Steve Jobs and Bill Gates were often quoted as saying they were so successful because they hired the smartest, most ambitious people they could find. Without a skilled, dedicated workforce, companies can fail spectacularly. It is a huge bottom-line cost for any company, though, and today’s industries are trying to replace humans everywhere they can, from driverless automobiles through to assembly-line robots. And it is not just about cost — it is about efficiency, speed, consistency, risk and reliability.

If workers call in sick or if they are injured, these are costs that companies must bear. Absent workers are also threats to productivity, which in turn threatens the bottom line. The ability to automate a company is the biggest aspiration for many industries now. But if the economy is to continue thriving with a consumer base that has money to purchase its goods and services, automation is a pressing dilemma because jobs are vanishing in response.

Capital is generally defined as being money, but when discussing factors of production, capital is defined differently. In this sense it is both money and capital goods, such as factories and warehouses, office space, production equipment — anything that is bought in order to produce an economic profit. On a farm, capital goods include the tractor, the barn, the delivery truck, even the desk and chair the farm’s accountant toils away at when balancing the books.

In a strong economy with expansion at the fore, companies invest in capital goods and this, in turn, drives the economic engine. A decade ago, the American economy collapsed while China continued to do well. During that time, American businesses pulled back on investing in capital goods while Chinese manufacturers increased spending on capital items like robots.

The result is that the robots helped improve everything from productivity to production costs in China. The investment in the capital goods themselves also drove employment, further boosting the Chinese economy.

Big companies get all the glory in business media, but the reality is that the American economy is driven by small businesses. It is entrepreneurs that create businesses and it is their ability to actualize their vision and build on their dreams that eventually dictates their success or failure. As success unfolds, entrepreneurs must acquire more space (land), buy more equipment (capital) and hire more people (labor).

It is entrepreneurs who successfully bring the other factors into play all in one fell swoop. When entrepreneurs invest in capital, land and labor, the economy thrives. There are approximately six million businesses in the U.S., but 5.8 million of them are classified as small businesses, and these are the entrepreneurs that literally put America to work; 65 percent of all new jobs are generated in small businesses.

When the economy thrives, all factors of production matter, but without entrepreneurship, there could be no economy at all. It is small business owners who invest in themselves and in opportunity that keep the economy moving forward.