Four factors of production | AP Microeconomics | Khan Academy

An idea that will keep coming up as you study economics is the idea of the four factors of production, which are usually listed as land, labor, capital, and entrepreneurship. The idea here is if you want to produce anything, so let's just say this circle is the production process and this arrow is the output, you need inputs. Now, you might have many, many, many inputs. You might need supplies, you might need a factory, you might need people to work in the factor. You need all of these different things.

But the idea of the four factors of production is that these things can all be classified in one of these four groups as either land, labor, capital, or entrepreneurship. Now, these words have meaning in everyday language, and so some of it might jump out at you. Of course, if you need to build a factory or if you need to farm, you need land to do so. You can see that in this example here where we see a farm; clearly, they need a lot of land in order to have the farm.

Even in a garment factory, this is a picture of a garment factory from maybe a hundred years ago. Even there, they needed land on which to build the factory. So this floor is sitting on land. Land doesn't just have to strictly mean land in an economics context; it can mean natural resources in general. This could be things like water or air or energy. So in some contexts, instead of land, some people might say natural resources for this first factor of production.

Now, another important factor of production, and arguably they are all important, is the idea of labor. To produce many or most things, someone has to work on it. So someone had to plant these seeds, and they will have to harvest these crops. The labor is very clear here; you see people putting in work in order to produce the product right over there.

Now, capital is an interesting one. It means one thing in everyday language, and it means something slightly more specific when we talk about it in an economics context. In an economic context, capital is something produced to produce other things. So examples of capital would be tools that you use to produce other things. It could be a building that you need in order to produce other things. It could be the machinery in a factory.

So these two pictures, there's many examples of capital. You could view this table and the tools that these folks are using; that is capital. You could view the whole building itself and all of the light fixtures and all of that as capital. So all of this stuff is capital: the hangers that they're putting the coats on after they produce it; that is capital. In this farm example, the capital would be the buildings; these were constructed so that they could produce the food from the farm. This little, it looks like some type of machinery there, that is capital for the farm; it's being used to produce the output of the farm.

Now, the place that that's different than everyday language, in everyday language when people talk about capital, they'll often include financial capital—financial assets that could be used to get benefit in the future, things like money. But in an economic context, we are not considering financial assets; we're only thinking about things that were produced in order to produce other things.

The fourth factor of production is entrepreneurship. Entrepreneurship in our everyday language means putting things together so you're trying to create other things. When someone's an entrepreneur, you might imagine someone who's trying to start a business. In an economic context, it has a related idea: entrepreneurship is putting together all of the other factors of production so that you can actually produce things. You can't just randomly build buildings and randomly plant seeds; someone has to think about how do you put these things together so that you can produce things in a reasonable way.

Obviously, you want to produce as much as possible given the other factors that you are putting into the production. A related idea—and it sometimes is used interchangeably in an economics course—is technology. So sometimes you'll see the four factors of production as land, labor, capital, and entrepreneurship, and sometimes you'll see it listed as land, labor, capital, and technology. But when you see technology as a factor of production, don't think about it as technology in an everyday language where you think of computer chips or software. When people are talking about technology as a factor of production, they are really talking about entrepreneurship; they're talking about the know-how of putting together the other factors of production in order to produce that output.

Finally, I want to leave on one idea: the idea of the two types of things that could be produced from all of these factors of production. Broadly speaking, we could produce something that could be used to produce more things. We already talked about it; we could be in that situation producing capital goods. So that could be that we are constructing a factory that itself maybe produces tools for other people to use in some other production process.

The other option we have is to produce what are known as consumption goods. Consumption goods are goods that are just used; they might make people happy, they might find pleasure in it, but it's not being used to produce other things. And because our production resources are scarce, there's a trade-off when a society, or a factory, or whoever decides how much capital to produce versus how much consumption goods.

You need some consumption goods; otherwise, frankly, we wouldn't have clothing on, we wouldn't be eating nice meals, we wouldn't be able to enjoy our lives. But at the same time, you also need capital. If we did only consumption goods, at some point we wouldn't have all the things we need to produce the consumption goods. So it's a very interesting trade-off that we'll explore more in future videos.