At this point in the series, we understand the concept of scarcity, and we also know
how to define resources, goods, and services.
But how are scarce resources turned into goods and services?
To answer that question, let’s take a look at the four factors of production.
First, you need land.
Now, sometimes, this is literally the land, but when economists talk about land, they
are talking about all of the natural resources found on the planet to help make goods or
provide services.
This could be fertile land for farming, but it could also be oil that comes from deep
underground, or water from a river, or timber from forests.
Second, you need labor.
Labor is the actual physical effort we put into making goods or providing services.
Whether this is a nurse taking care of a patient, an artist creating a painting, a mechanic
changing the brakes on a car, or a YouTuber making educational tutorials, work has to
go into producing a good or service.
Third, you need capital.
In this context, capital refers to any human-created resource that is used to produce other goods
and services.
There are two types of capital, physical capital and human capital.
Physical capital is the physical, human-made stuff that produces other stuff or aids in
the production of other stuff.
For example, a tractor is physical capital because it helps the farmer plow fields to
produce crops.
Human capital is the knowledge and skills a person gains through both education and
experience.
The farmer knows how to plow those fields because they have spent years doing it.
An economy needs both physical and human capital in order to function properly.
For example, it’s nice if the farmer has a tractor, but if they don’t know how to
use it, it’s not going to work.
The fourth factor of production is entrepreneurship.
Entrepreneurship is the process of launching and running a business in order to make money.
An entrepreneur takes on financial risks in the hopes of making a profit.
They create new ideas, and sometimes even create new markets and industries.
They also manage the other three factors of production.
A successful business knows how to efficiently manage land, labor, and capital in order to
make a profit.
To demonstrate the four factors of production, let’s consider an example of a company,
like say, an artisanal coffee shop.
The first factor that comes into play is entrepreneurship.
One or more entrepreneurs must be inspired to sell high-quality coffee in planning to
open up this coffee shop.
Second, the entrepreneurs need land.
This land includes where the coffee shop would be located, like perhaps this neighborhood
in San Francisco.
However, remember, land includes all natural resources.
So fresh water and coffee beans would be included here, and the beans could actually be considered
the most important natural resource.
Third, the entrepreneurs need to implement labor to construct, open, and operate the
coffee shop.
This takes work, and they likely have to hire additional workers to help them.
But who should they hire?
This is where human capital comes in.
They will need people with customer service skills and coffee making skills.
And don’t forget physical capital.
The workers will need coffee bean grinders, coffee makers, espresso makers, ovens, cups,
plates, silverware, and more.
With all four factors of production met, a delightful artisanal coffee shop has been
produced.
So to summarize, factors of production are the resources we need to make all goods and
services.
However, the four factors of production are only the beginning, as goods and services
also must be distributed.
So let’s move forward and learn about how trade is critically important in order for
goods and services to reach the maximum amount of people possible.