The Production Function and the Four Factors of Production

Land#

Land is the nat­ural fac­tor of pro­duc­tion. In eco­nom­ics the word means much more than an area of ground: it is a gift of nature and includes the dry sur­face of the earth and the nat­ural resources on or under the earth’s sur­face, such as forests, rivers, sun­light, etc.

Land is avail­able in a fixed quan­tity, so it has no sup­ply price: a change in the price of land does not change its total sup­ply. The return to land is called rent.

The char­ac­ter­is­tics of land are:

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

Labour#

Labour is the human fac­tor of pro­duc­tion: the phys­i­cal and men­tal effort that peo­ple put into pro­duc­ing goods and ser­vices.

It includes unskilled, semi-skilled and highly skilled labour. The sup­ply of labour responds to its price, ris­ing when wages rise. The return to labour is called wages or salary.

Char­ac­ter­is­tics of labour#

• Human Effort.
• Labour is per­ish­able.
• Labour is an active fac­tor.
• Labour is insep­a­ra­ble from the labourer.
• Labour power dif­fers from labourer to labourer.
• All labour may not be pro­duc­tive.
• Labour has poor bar­gain­ing power.
• Labour is mobile.
• There is no rapid adjust­ment of sup­ply of labour to the demand for it.
• Choice between hours of labour and hours of leisure.

Cap­i­tal#

Every busi­ness also needs a fac­tory, machines or other equip­ment. Cap­i­tal refers to these man-made resources used in pro­duc­tion. It is wealth cre­ated by human beings and an impor­tant fac­tor in the pro­duc­tion of any kind of goods and ser­vices, as pro­duc­tion can­not take place with­out the involve­ment of cap­i­tal.

Cap­i­tal is an out­put of a pro­duc­tion process that goes into another pro­duc­tion process as an input. Cap­i­tal as a fac­tor of pro­duc­tion is divided into two parts, namely, phys­i­cal cap­i­tal and human cap­i­tal.

Phys­i­cal cap­i­tal includes tan­gi­ble resources, such as build­ings, machines, tools and equip­ment, etc.

Human cap­i­tal includes the knowl­edge and skills of peo­ple, gained through edu­ca­tion, train­ing and expe­ri­ence.

The return to cap­i­tal is called inter­est.

Types of Cap­i­tal#

• Fixed cap­i­tal
• Cir­cu­lat­ing cap­i­tal
• Real cap­i­tal
• Human cap­i­tal
• Tan­gi­ble cap­i­tal
• Indi­vid­ual cap­i­tal
• Social Cap­i­tal

Entre­pre­neur­ship#

Lastly, an entre­pre­neur is some­one who com­bines all of the resources - land, labor, and cap­i­tal to pro­duce a prod­uct or ser­vice. Entre­pre­neurs make deci­sions regard­ing the pro­duc­tion process and the best way to uti­lize the fac­tors of pro­duc­tion.

Entre­pre­neur­ship involves coor­di­na­tion, man­age­ment and super­vi­sion. The entre­pre­neur cre­ates the enter­prise, and its suc­cess or fail­ure depends on how well the entre­pre­neur works. The return to entre­pre­neur­ship is profit.

An enter­prise is an organ­i­sa­tion that under­takes com­mer­cial pur­poses or busi­ness ven­tures and focuses on pro­vid­ing goods and ser­vices. An enter­prise is com­posed of indi­vid­u­als and phys­i­cal assets with a com­mon goal of gen­er­at­ing prof­its.

Func­tions of an entre­pre­neur#

• Ini­ti­at­ing busi­ness enter­prise and resource co-ordi­na­tion.
• Risk bear­ing or uncer­tainty bear­ing.
• Inno­va­tions.

Short run and long run#

In the long run, firms can change all their inputs to max­imise profit, but in the short run some inputs can­not be changed. This gives two kinds of fac­tor.

• Fixed fac­tors refer to those aspects of pro­duc­tion that remain the same regard­less of changes in the out­put.
• Vari­able fac­tors are those that may change as out­put changes.
• The pro­duc­tion func­tion is writ­ten Q = f(K, L), where Q is the out­put, f refers to func­tion, K is the cap­i­tal and L stands for labour.
• Accord­ingly, there are two kinds of pro­duc­tion func­tion: the short-run and the long-run pro­duc­tion func­tion.

Key terms#

Pro­duc­tion Func­tion (PF)

In eco­nom­ics, a pro­duc­tion func­tion gives the tech­no­log­i­cal rela­tion between quan­ti­ties of phys­i­cal inputs and quan­ti­ties of out­put of goods.

Com­mon ques­tions#

What is a pro­duc­tion func­tion?#

A pro­duc­tion func­tion is defined as a func­tion that rep­re­sents the quan­tity of out­put a firm can pro­duce given a cer­tain quan­tity of input com­bi­na­tion.

What is the impor­tance of pro­duc­tion func­tion?#

It shows the rela­tion between input and out­put. It helps firms esti­mate their over­all pro­duc­tion and plan accord­ingly.

What is meant by the law of dimin­ish­ing returns?#

The short-run pro­duc­tion func­tion adheres to the law of dimin­ish­ing mar­ginal returns. As more units of the vari­able input are added, the addi­tional out­put will even­tu­ally decrease due to the con­straint of fixed inputs.