BCom 1st Year Production and Factors of Production Notes Study Material

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BCom 1st Year Production and Factors of Production Notes Study Material

Meaning of Production

In everyday usage the word ‘Production’ means creation of something. But man cannot create material things. “In the mental and moral world indeed he may produce new ideas; but when he is said to produce material things, he really produces utilities, or in other words, his efforts and sacrifices result in changing the form or arrangement of matter to adapt it better for the satisfaction of wants.”

Hyman describes production as “the process of using the services of labour and equipment together with other inputs to make goods and services available.” -Micro-economics

In the physical world what we can do is to readjust matter so as to make it more useful. As an example we can look at the work of a carpenter. When he makes a log of wood into a chair, all that he has done is to readjust the log in such a manner as to make it more useful. Similarly, when a farmer puts seed in land, it is the nature that makes it burst out into life and thereby made more useful. Like the carpenters and the farmers, traders, too, produce utility and cannot do anything more.

Consumption is negative production. “Just as man can produce only utilities, so he can consume nothing more. He can produce services and other immaterial products, and he can consume them. But as his production of material products is really nothing more than a rearrangement of matter which gives it new utilities; so his consumption of them is nothing more than a disarrangement of matter, which diminishes or destroys its utilities.”

Production, in economics, is not restricted to the manufacture of commodities, such as motor-cars, ships, machines, etc. (manufacture means no more than putting together certain quantities of different kinds of materials) but also includes the provision of services, such as those of the lawyer, doctor, actor, teacher, etc. People engaged in service aim at satisfying other people’s wants Just as the workers in a motor-car factory do. The work of distribution-wholesale and retail trade, transport, etc.-is also part of the productive process. It is so because production is not complete until the commodity that has been manufactured has actually reached the persons who desire it.

Production thus covers the following activities:

(i) Changing the form of a good at any stage from the raw material to the finished product, as for example, weaving cotton into cloth, conversion of sugarcane into sugar, etc. This type of production is called creation of “form of utility”, that is, change of form increases the utility of the good. Thus cloth has more value than cotton, sugar fetches higher price than sugarcane, etc.

(ii) Changing the situation of a good as, for example, from a factory in Kolkata to a retail shop in Bhagalpur. It is creation of “place utility”. It gives a commodity an additional value—it is cheaper in factory but quite costlier in the retail shop.

(iii) Changing the position of a good in time as, for example, holding stocks of goods until they are required. Keeping wheat, for instance, in godowns during the harvest time in order to sell it a higher price afterwards is an example of this type of production known as creating “time utility”. It is time which gives the goods higher value.

Factors of Production

Production is a co-operative endeavour. Factors that co-operate in the production process are called factors of production (or means of production or agents of production). According to Marshall, factors of production are the things required for making a commodity. In modern terminology they are referred to as ‘inputs’. Thus agents or factors of production are productive resources. “The term input is perhaps to be preferred to agent or factor of production, for an agent implies the playing of an active role, whereas these three factors (land, labour and capital) are better considered merely as resources at the disposal of the organisers of production.”

Factors of production are generally grouped into Land, Labour and Capital for broad purposes of analysis, while entrepreneurship is also included as a fourth one.

The extent and quality of a country’s resources of land, labour and capital are one of the principal influences on any country’s total volume of production. It should further be noticed that it is the services of the factor, rather than the factor itself, that contribute towards production.

Land

In economics land means not only the surface of the earth, not covered by water, but all the free gifts of nature, such as minerals, forests, fertility of soil, resources of the sea, etc. which can be used in the process of production. Land provides both space and specific resources. Thus land is the generic name given to the free gifts of nature

Much semantic argument has taken place on the extent to which land as a factor of production is “really distinct” from capital. As Marshall says, those material things which owe their usefulness to human labour are put under capital, but those which owe nothing to human labour is classed as land. He agrees that this is a loose distinction. A few examples will make is clear:

• Bricks are but pieces of earth slightly worked up.
• Many of the services of land require expenditure of resources to obtain or maintain them.
• The soil of old settled countries in its present form has been worked out by human labour.

Marshall is the opinion that there is a scientific basis for the distinction between land and capital. Man has no power of creating matter. He only creates utilities by arranging things into a useful form. It is because of such utilities that these things cannot be had free, they have a supply price.

There are however, other utilities over which man has no control; they are given as a fixed cuantity by nature. So they can be had free, they have no supply price. These utilities have been referred to as “the original and indestructible power of the soil” by Ricardo, while Von Thunen means by it the soil as it would be by itself, if not altered by the action of man.

Marshall defines it in these words: “The term ‘land’ has been extended by economists so as to include the permanent sources of these utilities, whether they are found in land, as the term is commonly used, or is seas and rivers, in sunshine and rain, in winds and waterfalls.”

Three reasons were given by earlier economists to treat land as separate and distinct from the other factors. They are:

(a) Land is a free gift of nature.

(b) Land is strictly limited in quantity so that even in the long period its supply cannot be increased.

(c) In those industries which are primarily dependent on land, production is subject to the law of diminishing returns. Samuelson and Nordhaus add that in today’s congested world, we must broaden the scope of land to include our environmental resources, such as air, water, land and climate.

Labour

While land is said to be the passive factor of production, labour is referred to as the active agent of production. Though production is a co-operative effort of all factors, labour is considered to be the most important factor of production.

Labour is the collective name given to the productive services embodied in human physical effort, skill, intellectual powers, etc. Accordingly, there are many types of labour input; they vary in effort and skill content and in particular types of skill content. It is a useful theoretical simplification to talk of the quantity of labour as homogeneous.

Labour differs from land and capital in the sense that it is supplied by human beings. So ethical and moral considerations need to be taken into account when dealing with it.

The term, supply of labour, is somewhat ambiguous. It may mean the total number of people of working age or the supply of labour services available. Since it is the service of labour rather than labour itself that takes part in production, bour service is the more useful concept. Supply of labour depends on the following three factors:

(a) Total population of the country;

(b) Proportion of the population available for employment;

(c) The number of hours worked by each person per year.

Since population is one of the factors of production, economists have always shown interest in population changes. The proportion of population available for employment depends mainly on

• the standard of civilisation reached by the country,
• the extent of its industrialisation,
• its social organisation,
• attitude of its people to work,
• the retirement age of the people,
• the period of education, and
• weekly working hours.

Longer period of education and shorter working week reduce the supply labour. It is offset to some extent by the consequent increase in the efficient of labour.

Productive and Unproductive Labour: Earlier economists divided labour into productive and unproductive. To the physiocrats of the eighteenth century France, only labour employed in agriculture was regarded as productive. Adań Smith widened it to include, besides agricultural labour, workers enjoyed in the manufacturing industry, while all services were regarded as unproductive Today such a distinction is not acceptable as production includes goods as well as services. Therefore, division of labour into productive and unproductive is not only pointless but also inaccurate. “The only labour that can be considered to be unproductive is misdirected labour, where effort has been wasted on the production of something that is incapable of fulfilling the function it was intended to serve.”

Capital

Land and labour are called primary or original factors of production, available before production takes place. Capital is a produced factor of production. The supply of land and labour is mostly determined by non-economic factors, such as the fertility rate and the country’s geography. Capital, by contrast, has to be produced before it can be used. Without the use of capital, method of production is direct, as for example, wading into a stream and grafting fish with hands. Method of production becomes time-consuming, indirect and roundabout when capital is used as a factor of production.

“Capital consists of those durable produced goods that are in turn used as productive inputs for further production. Some capital goods might last for a few years, while others might last for a century or more. But the essential property of a capital good is that it is both an input and an output.”

Capital can be divided into the following three major categories:

(a) Structures, such as factories and homes;

(b) Equipment, such as consumer durable goods like automobiles and producer durable equipment like machine tools and computers; and

(c) Inventories of inputs and outputs, such as cars in dealers’ lots.

A lengthy discussion had taken place among economists, in the past whether to treat such things as houses as capital goods or not. At present are treated as durable consumer goods. It is true that capital goods and durable consumer goods have many common features, but they serve rather different purposes.

Capital goods produce consumer goods or further capital goods, while durable consumer goods do no such things. A man’s or society’s total wealth is the total stock of tangible and intangible possessions which have a market value Capital is that part of wealth which is devoted to acquiring income. In other words, capital is wealth used for the production of further wealth.

We may conclude by stating that the “term capital is used to describe all those instruments of production which are deliberately made by man to carry on production in future. Capital is unique among the factors of production in that man exercises complete control over its creation.”

Wealth and Capital

It can be confusing if capital is treated as the same thing as wealth. Wealth is a stock of goods existing at a given time that

• yield utility,
• have a money value,
• are limited in supply, and
• the ownership of which is transferable from one person to another.

Capital, a factor of production, is that particular type of wealth that

• are used to assist production, and
• yield income.

Adam Smith defined a man’s capital as “that part of his stock from which he expects to derive an income.” Marshall made this definition more precise by excluding land which also yields an income. Capital is man-made, while land is a free gift of nature.

Money, Wealth and Capital

Money is simply a means of exchange. It becomes capital only when it gives command over a producer’s goods. In a modern economy the society as a whole cannot regard money as either wealth or capital. Suppose there is an increase in the quantity of money. This will not make the community one iota richer than before unless there is a corresponding increase in the quantity of goods. Mere increase in the quantity of money will raise prices and lower the value of money-increased quantity of money purchasing no more than what it did previously.

Money can, however, be exchanged for capital goods or any other kind of goods. To an individual then money can be considered as wealth. From this viewpoint, the businessman can look upon money as capital. “When people save, they save money. When they invest by buying shares in a new company they purchase them for money, but the company desires the money only because it can be converted into real capital goods-factory buildings, machinery, raw materials, etc.”?

Organisation or Entrepreneur

Early nineteenth century economists spoke of only three factors of production, namely, land, labour and capital. Marshall thought that organisation was sometimes worthy of being considered as a separate factor. Since then many other economists have recognised the entrepreneur or organiser as an independent factor.

Entrepreneur is a separate factor of production. He is the employer, while all other factors are employed by him. The entrepreneur is responsible for arranging how a piece of work shall be carried out. His organising in fact covers w the factors he employs. He is responsible for such economic decisions as:

• what to produce,
• how much to produce,
• what method of production to be used, and
• where the establishment to be located.

Entrepreneur, as an input, is regarded in economic analysis of the firm a factor of production in its own right. There are three main functions of entrepreneur:

(i) Uncertainty bearing: There is a gap in time between the decision produce and marketing of the product. In between, entrepreneurs anticipati of demand may undergo change. It follows that the entrepreneur bears the risks relating to the fluctuations in demand during this interval.

Risks are of two kinds: (i) Some risks, such as fire, theft, loss of goods: transit, etc., can be insured against as probability of occurrence can he measured statistically. There are other methods too by which risk can reduced. Whenever risk is reduced in this way, the pure entrepreneuria function is also lessened. (ii) Some risks, however, are such that cannot be insured against because their probability can not be statistically calculated. To day producers generally do not embark on production until they have received orders, rather they go on producing in anticipation of demand.

Such risks, i.e. risks of marketing cannot be insured against and they have been called uncertainty by Frank Knight. Entrepreneurs bear such risks. Thus uncertainty bearing is the main function of the entrepreneur.

(ii) Arrangement of Finance: The entrepreneur has to arrange finance of the firm. Where production is on a small scale, the entrepreneur is the owner-manager of a firm. He is likely to supply his own capital. The typical modern business unit is the limited company. In the large joint-stock limited liability companies, the entrepreneurial functions are divided. Finance is supplied by individuals and institutions who make loans on fixed interest, buy bonds and debentures or ordinary shares.

The firm is actually owned by its ordinary shareholders and bear the risks of the enterprise. The functions of decision-taking in the firm, and the actual taking of risks (as opposed to risk-bearing) are carried out by the board of directors and salaried executives of the company. Thus there is no single entrepreneur in the most important companies of the present day economy. Like the firm itself in economic theory, the entrepreneur is a theoretical abstraction; it has an empirical counterpart in many small firms in the economy.

(iii) Management Control: The responsibility for broad decisions of policy rests with the entrepreneur. He has to choose the rate of output in the light of the expectation of demand. He must be capable of choosing the right type ol persons to whom some decision-making power should be delegated. In the absence of delegation of powers, there would be too much centralisation which delays decision. The entrepreneur has to decide his scale of production and the proportion in which to combine other factors of production that he employs.

Entrepreneur and Labour

There are some economists who do not distinguish between labour as entrepreneur as factors of production. They argue that a certain amount o organising is required of all, no doubt more in some cases than in others. “The only difference, therefore, between the managing director and one of lowest-ranking employees, they say, is that the managing director is prima concerned with organisation and devotes nearly the whole of his time to whereas….the organisation required of an employee is only a preliminary to his ordinary work and occupies only a small fraction of his time.” Thus, those who do not make distinction between labour and entrepreneur or organiser, maintain that

• both do the work of organisation, though
• entrepreneur devotes his whole time to organisation, while labour devotes only a fraction of his time to it.

But those who make a distinction between the two and regard repreneurship as a separate function point out that the organisation work of an entrepreneur is not merely on a wider scale but also different in kind. Entrepreneur’s organising covers all the factors he employs and bears the risk or uncertainty of the enterprise which the labour does not bear. Entrepreneur’s Comuneration is residual in nature. After paying rent to land, wages to labour and interest to capital, if anything remains that will be his remuneration known as profit.

Specific and Non-specific Factors

Objections have been raised against classifying factors into rigidly defined groups of land, labour and capital.

(i) Substitution between Units of the same Factor is not always possible. The factors are not homogeneous. Every group does not consist of identical units. All land is not alike. So if one piece of land is suitable for growing one crop, say jowar or bajra, it cannot be used for growing paddy. Similarly there are many kinds of labour which are not interchangeable. The services of a doctor cannot be substituted by those of a lawyer or an engineer. There are many types of capital too and the one cannot be interchanged for the other.

“There are many kinds of land, many kinds of labour and many different kinds of capital. It would be more logical to recognise hundreds or even thousands of separate factors—each distinctive type of land, labour and capital being considered a factor in its own right—than to limit the number of factors to three or even four.”

(ii) Substitution between different factors is often possible. “Although each unit of a factor such as land is not a perfect substitute for either capital or labour, it is frequently possible nevertheless to substitute some land for either capital or labour, that is, more labour might be employed on a smaller piece of land or more capital in the form of machines or fertiliser, thereby making farming more intensive. ” In capital-intensive technique of production, capital is substituted for labour, whereas in labour-intensive technique labour is substituted for capital. Similarly, in intensive cultivation, labour and capital are substituted for land.

Therefore, differences between the three factors, land, labour and capital, ording to some economists, are only superficial. Economically they are all ular to one another. But factors of production are not perfect substitutes for e another. So the entrepreneur cannot dispense with any of them, he has to ploy a certain amount of each. Over this minimum amount he has a choice, can employ a little less labour and more capital or a little more labour and land. This is the Principle of Substitution.

Thus, the classification of factors of production into three groups has been subject to objection because:

• substitution between units of the same factor is not always possible, and
• substitution between different factors is often possible.

Some economists maintain that, because of the above difficulties, it is more useful to classify factors of production into specific and non-specific factors. This classification emphasizes the similarity of the factors. Within each category-specific or non-specific examples of all three factors, land, labour and capital, can be found. “A factor is said to be specific if it is of a specialised kind, and therefore cannot easily be used for any purpose other than that for which it was on originally intended.”I Examples of it can be found in land, labour and even in capital. A blast-furnace is an example of capital which cannot be used for any other purpose. A highly trained labour is another example.

“A factor of production that can fairly easily be transferred from one use to another can be considered to be non-specific.”

Most of the land, unskilled labour, ordinary tools, raw materials in general are non-specific.

Original or Basic Factors

Some economists have argued that there are not four factors of production but only two original or basic factors of production, namely, land and labour.

Land, as the free gift of nature, is a basic factor of production distinct from all other factors. Labour is another original factor which includes all types of work, both physical and mental. As Marshall says, “In a sense there are only two agents of production, nature and man. Capital and organisation are the result of the work of man aided by nature…. If the character and powers of nature and of man be given, the growth of wealth and knowledge and organisation follow from them as effect from cause. But on the other hand man is himself largely formed by his surroundings, in which nature plays a great part.”

The above argument may be logical but not realistic. Labour is a broad term referring to every man’s physical and mental talents usable in producing goods and services. But entrepreneurial ability is an exceptional human talent. In a capitalist economy it has special significance and therefore needs to be treated separately. This term is given special meaning by assigning four related functions to the entrepreneur:

• He takes initiative in combining land, labour and capital in the production of goods and services;
• He takes basic business policy decisions that are non-routine in nature,
• He is an innovator; and
• He is a risk taker.

Entrepreneur’s remuneration is non-contractual whereas other facto rewards are contractual. It follows from all this that entrepreneur is diffe from labour. Capital too needs to be treated as a separate category. It full real need.

Thus the conventional division of factors of production into four is retained as it seems “more useful and more simple or more obviously in accord with facts.”

Relative Importance of the Factors of Production

Production being a co-operative endeavour, it does not make much sense in saying that some factor or factors are more important than others. But when land and labour are called original factors of production, the conclusion is inevitable that they are more important than the other two factors. Now if land To passive agent of production and labour an active means, naturally labour. assumes greater importance than land.

In primitive society, land might have been the most important factor. Gradually, however, with the progress of civilisation, the importance of labour began to grow. In the beginning of capitalism capital began to assume greater importance as the method of production became more and more indirect, roundabout and capitalistic. With the advent of large corporations, organisation began to assume ever greater significance.

Thus though all factors are necessary for modern production, they have not been always equally important.

The importance of a factor varies with the stage of economic development. Further, the relative importance of the factors of production varies from industry to industry and with the scale of production.