Production and factors

of
Production

Business economics

Production
Production is a process of combining various material inputs and immaterial inputs (plans, know-how) in
order to make something for consumption (the output). It is the act of creating output, a good or service
which has value and contributes to the utility of individuals. It does not include simply making of things
but what is made must be designed to satisfy wants.

Factors of production
Production depends on four principle factors. These factors include any and all external stimuli and
features that a company may use or encounter during production. These are:

 Land: types of natural resources used to create goods and services.

 Labour: all types of human efforts – physical, mental, use of intellect etc. made for an economic
reward.
 Capital: part of company wealth that is currently in productive use.
 Entrepreneur: one that initiates the process of production by mobilizing the other factors of
production to make a profit.

Characteristics of Factors of Production

Land

Free gift of nature: can be used without paying any money i.e. it does not have a supply price.
Fixed supply: the quantity of land in existence will always remain the same i.e. its supply is perfectly
inelastic from an economic view. It is however abundant for a single firm therefore is relatively elastic
from a firm’s point of view.
Permanent: cannot be destroyed or lessened in amount. Can only be upgraded or degraded.
Immobile:Cannot be moved from its place of origin.
Multiple uses: can be used for various reasons.
Heterogeneous: can differ in quality. One piece of land may be suitable for one purpose (e.g. building a
factory on a barren land) but not another (e.g. farming).

Labour

Perishable: cannot be stored. If a worker does not work for one shift his labour of that shift is lost
completely. It cannot be stored and utilized the next day.
Depend on the labourer: requires the physical presence of the labourer at all times of production.
Human effort: depends on factors affecting labourers like fair treatment, rest times etc.
Heterogeneous: no two labourers are the same and neither is their quality of work.
Inelastic supply: cannot be produced instantly since acquiring skills can take years

Capital

Passive: requires labour to be productive.

Variable: increases or decreases according to the needs of the firm
Mobile: easiest factor of production to move.
Destructible: can lessen in amount if not recovered.

Entrepreneur
There is no fixed number of characteristics since entrepreneurs are human and thus can be infinitely
heterogeneous.

Production of Unit by Firm and Industry

A unit of production is the individual or group responsible for making a product. Carpenters are the unit
of production for producing furniture within a society. A firm can be a unit of production when it takes
certain raw materials and add utility to them by using resources like labour to make a product; for
example: Shell oil takes crude oil and distills it to make various usable products like petrol. An industry is
a unit of production when it is responsible for producing all types of a particular product, e.g. The
automobile industry produces vehicles.

Efficiency of labour
The ability to increase output without increasing the quantity of input is called efficiency of labour.
Increase in efficiency is usually expressed in terms of increase in output of labor within a shorter period of
time without any fall in the quality of goods and services produced. It depends on many factors such as
education, training, skill, intelligence and health of laborers, working conditions, wages etc.

Mobility of labour and its importance for Economic development

Mobility of labour means the capacity and ability of labour to move from one place to another or from one
occupation to another or from one job to another or from one industry to another. There are three types:
Geographical Mobility: worker moves from one place to another within a country or abroad.
Occupational Mobility:
a) Horizontal; from one occupation to another in the same grade or level. .
b) Vertical: from lower grade in an occupation moves to another occupation in a higher grade and status.
Mobility between Industries: from one industry to another in the same occupation in industrial
mobility.

The mobility of labour helps in increasing efficiency and productivity of workers when workers move to
occupations for which they are suited the best. It also increases their incomes when they shift from low
paid to high paid jobs. It solves the unemployment problem when workers move to places where they are
wanted and away from decaying industries. It thus increases production, employment and income.

Factors affecting mobility of labour

Education and Training: increase the chances of occupation change or geographical mobility.
Ambition: urge of workers to rise in life.
Means of Transport: ease of daily travel and for emergencies.
Industrialisation: Workers move from different occupations and rural places to work in factories in
industrial centers and big cities.
Trade: leads to the spread of their offices and institutions related to them in the country. As a result
workers move from one place and occupation to another to work in trade and business offices.
Advertisement: informs workers of employment opportunities in different areas.
Law and order: safer living conditions encourage people to move to such areas for work.
Immigration policies: a country with open immigration policies will attract skilled labor e.g. Australia.

Division of labor
The specialization, of work by splitting up of a task into a number of processes and sub-processes and
carrying it out by a person or a group of persons who are best fitted for it. This is used to increase and
maximize the efficiency of a production design and reducing the cost of production while increasing profit
as a result. There are at least five different types of division of labour:

(a) Division into trades and professions (e.g.shoe making by shoe-makers)

(b) Division of labour into complete processes (e.g. spinning of cotton by spinners)
(c) Division of labour into incomplete processes (e.g. turning of screws constantly by a labour)
(d) Territorial division or localisation of industry (e.g. concentration of jute mills in West Bengal)
(e) International division of labour (e.g. Switzerland for chocolate)

Advantages and Disadvantages of labour

Advantages

 Increased productivity(higher output per worker per hour)

 Increased productivity leads to reduced cost per unit of output and therefore increases efficiency.
 Higher living standards due to reduced cost per unit
 Worker becomes highly skilled in a particular task due to repetition
 No time is wasted moving from one job to another
 Less time required to train workers for specific tasks
 More choice as workers can specialize in jobs they are most suited to

Disadvantages

 Repititon creates boredom and monotony

 Breaking down the production process into different tasks encourages automation which this leads to
structural unemployment
 Division labour creates interdependence in production. If one group of workers goes on strikes it
brings the whole production process to a halt.
 Loss of horizontal mobility and risk of unemployment due to lack of knowledge required to change
occupations and thus difficulty in finding a new job which requires the same set of skills.

Capital and its types

Any material quantity that has value and using which brings revenue to the business is called capital. It
can be used to increase value across a wide range of categories such as financial, social, physical,
intellectual, etc. For e.g. a fisherman's boat which he uses to catch fish is his capital. In economics there
are four types:
Human Capital: resources which are related to humans and their capabilities. For e.g. Labor and Skills,
Intelligence, Social Networks, Political Systems, Trust and Reputation, and influence and Power.
Financial Capital: is related to money and its related policies and instruments. For e.g. cash, debt, and
other monetary policies.
Environmental Capital: refers to natural resources that may be utilized for profit or sustainability.
Manufactured Capital: refers to human-made infrastructure, machines, tools, factories, etc.

Importance of mobility of capital and its merits

The ability and ease of physical assets and finance to move across geographical boundaries is called
mobility of capital. High capital mobility has the following advantages:
FDI: easier to attract Foreign Direct Investment. It will also increase investment opportunities abroad.
Better rate of return: easier to move financial capital around to gain higher yields and interest rates.
Real exchange rates parity: reduces differences in real exchange rates. Cheaper goods in a country
would encourage people to buy goods there and transfer capital to low-cost countries.
Help equalize incomes between different countries: E.g. European firms to invest in developing
countries who have lower wage rates. These capital inflows could help raise wages in developing
economies.

Factors that encourage capital immobility

Low taxes on capital flows: capital flows may be taxed by the government. e.g. tax on investment or
capital gains tax on profitable capital flows. Low taxes encourage capital mobility.
Restrictions on capital flows: restrictions on the amount of capital that can be taken into and out of a
country. For e.g.: capital controls on individuals taking foreign currency out of the country
Rules and Regulations. Governments can impose rules which increase the cost of moving capital from
one country to another.
Exchange Rate Volatility: a volatile exchange rate, this may discourage investors who will be worried
about a devaluation in the exchange rate which reduces the profitability of investment.

Capital accumulation and formation

An increase in assets from investment or profits is call capital accumulation. Individuals and
companies can accumulate capital through investment.
The net capital accumulation during an accounting period for a particular country is called capital
formation. The term refers to additions of capital stock, such as equipment, tools, transportation assets
and electricity. Generally, the higher the capital formation of an economy, the faster an economy can grow
its aggregate income.

Stages of capital formation

In the modern free-market economy, the process of capital formation consists of the following three
stages:
1. An increase in the rate of real savings so that resources that would have been devoted to the production
of consumption goods should be released for the purpose of capital formation.
2. Existence of a good financial system so that the available resources are obtained by private investors
for capital formation.
3. The act of investment itself so that resources are actually used for the production of capital goods

Sources of capital accumulation for the government

The stock of capital goods of a country can be built up and increased through two main sources:

(1) Domestic Resources

(2) External Resources

Domestic resources

Voluntary savings: Households and business sectors save a part of their current income which is then
used as a source for capital formation in the country.
Involuntary savings: taxes collected by the government from the general public. Government generates
resources through taxes which are then used for capital formation.
Government borrowing: The government issues short term and long term bonds to commercial banks
and general public and collects resources which are used for capital formation in the country.
Use of idle resource: unutilized and underutilized resources when properly used can be a valuable
source of capital. For example in villages side employment rate is very high if the government engages
unemployed people in the construction of roads.

External resources

Donor Country and the Economic Assistance: Government of Pakistan receives foreign aid from
international financial institution and advanced countries of the world and collects more and more
sources for capital formation in the country.
Foreign Investment: Some of the International financial agencies have invested in Pakistan and have
provided services of trained persons to increase the capital formation

Entrepreneurship and its functions

The capacity and willingness to develop, organize and manage a business venture along with any of its
risks in order to make a profit. An entrepreneur uses land, labour and capital to produce profit.
Entrepreneurs have three main functions:

Innovation: They should be able to translate an idea or invention into a good or service that creates
value or for which customers will pay. Innovation involves deliberate application of information,
imagination and initiative in deriving greater or different values from resources, and includes all
processes by which new ideas are generated and converted into useful products.
Risk-Taking: They should be ready to face any unexpected risk while going through the
entrepreneurship process. The should be intelligent enough to diversify the risk in
1) production
2) investment
3) expansion of the enterprise
Building of Organization: They should have enough organizing and managing skills to utilize the
resources with minimum loss and bring down the production costs. Being the sole decision maker for the
enterprise, the entrepreneur should be able to make decision regarding which parts of the business need
to expanded and where the investment should go to.

Types of Business Organizations

There are three basic types of business ownerships:

1. Proprietorship: is owned by a single individual. The individual or person who owns this type of
business is referred to as Proprietor. Easy and cheap to organize. However, business resources are limited
to the ownaer who assumes all the risk, liability and decision making of the business. E.g. shop owners
etc.

2. Partnership: formed for bigger businesses who needs more financial, people and managerial
resources. Two or more individuals (Partners) may join together and form a business called partnership.
It is a little harder and more expensive to organize than the proprietorship. However, the risk, liability
and management is shared by group of individuals, depending on the percentage of ownership agreed
upon.

3. Corporation: is owned by shareholders and it is structured as a separate legal entity under the
operation of law. The ownership of a corporation is divided into shares of stock. A corporation issues the
stock to individuals or other businesses, who then become owners or stockholders, of the corporation.

The benefit of the corporation is that the risk and liability is not shouldered by the owners called as
stockholders. And the management or decision making is shared by the board of directors. Also, it is
easier to increase resources of the business by means of issuing stock.
Large size businesses usually form a corporation because of its complexity and high need of resources.