The factors of production

    Main idea: Scarce resources require choices about uses of the factors of production: land, labor, capital, and entrepreneurship. If you have a job, how does the work you do fit in with the bigger economic picture? Read on to learn that labor is one of the factors of production.

    When economists talk about scarce resources, they are referring to the factors of production, or resources needed to produce goods and services. Traditionally, economists have classified these productive resources as land, labor, capital, and entrepreneurship.

   Land As an economic term, land refers to natural resources that exist without human intervention. “Land” includes actual surface land and water, as well as fish, animals, trees, mineral deposits, and other “gifts of nature.”

    Labor The work people do is labor—which is often called a human resource. Laborincludes any work people do to produce goods and services. Goods are tangible items that people can buy, such as medicine, clothing, or computers. Services are activities done for others for a fee. Doctors, hair stylists, and Web-page designers all sell their services.

  Capital Another factor of production is capital—the manufactured goods used to make other goods and produce other services. The machines, buildings, and tools used in making automobiles, for example, are capital goods. The newly assembled goods are not considered capital unless they, in turn, produce other goods and services, such as when an automobile is used as a taxicab.

   When capital is combined with land and labor, the value of all three factors of production increases. Think about the following situation. If you combine an uncut diamond (land), a diamond cutter (labor), and a diamond-cutting machine (capital), you end up with a highly valued gem.

Capital also increases productivity—that is, greater quantities of goods and services are produced in better and faster ways. Consider how much faster an optical check-reading scanner—a capital good—can sort checks as compared to an individual worker reading each one.

  Entrepreneurship The fourth factor of production is entrepreneurship. This refers to the ability of individuals to start new businesses, introduce new products and processes, and improve management techniques. Entrepreneurship involves initiative and willingness to take risks in order to reap profits. Entrepreneurs must also incur the costs of failed efforts. About 30 percent of new business enterprises fail. Of the 70 percent that do survive, only a few become wildly successful. 

  Technology Some economists add technology to the list of factors of production. Technology includes any use of land, labor, and capital that produces goods and services more efficiently. For example, computerized word processing was a technological advance over the typewriter. Today, the word technology is commonly used to describe new products and new methods of producing goods and services.

   Effect on Income and Wealth How much of each of the factors of production an individual has determines his or her wealth. The more land and capital you have, the richer you will probably be. The greater your entrepreneurial skills, the more income you might earn. In other words, the distribution of factors of production affects a nation’s income distribution—what percentage of Americans are rich and what percentage are poor. The same holds true across nations as well. Nations with many natural resources at their disposal, for example, tend to be wealthier than nations with few natural resources.

Unit 2

  TRADE-OFFS

Main idea: Economic decisions always involve trade-offs that have costs. Think about the last time you spent an hour watching television. Were there other ways you could have spent your time? Read on to learn about how using resources one way means giving up other alternatives.

  The economic choices people make involve exchanging one good or service for another. If you choose to buy an iPod, you are exchanging your income for the right to own the iPod. Exchanging one thing for another is called a trade-off.

  Individuals, families, businesses, and societies are forced to make trade-offs every time they use their resources in one way and not another.

  The Cost of Trade-Offs The cost of a trade-off is what you give up in order to get or do something else. Time, for example, is a scarce resource—there are only so many hours in a day—so you must choose how to use it. When you decide to study economics for an hour, you are giving up any other activities you could have chosen to do during that time.

   In other words, there is a cost involved in time spent studying this book. Economists call this an opportunity cost— the value of the next best alternative that had to be given up to do the action that was chosen. You may have many trade-offs when you study—exchanging instant messages with your friends, going to the mall, watching television, or practicing the guitar, for example. But whatever you consider the single next best alternative is the opportunity cost of your studying economics for one hour.

   A good way to think about opportunity cost is to realize that when you make a trade-off (and you always make trade-offs), you lose something. What do you lose? You lose the ability to engage in your next highest valued alternative. In economics, therefore, opportunity cost is always an opportunity that is given up.

     Considering Opportunity Costs  Being aware of tradeoffs and their resulting opportunity costs is vital in making economic decisions at all levels. Whether they are aware of it or not, individuals and families make trade-offs every day. Businesses must consider trade-offs and opportunity costs when they choose to invest funds or hire workers to produce one good rather than another.

    Consider an example at the national level. Suppose Congress approves $220 billion to finance new highways. Congress could have voted instead for increased spending on medical research. The opportunity cost of building new highways, then, is less medical research.

    Production Possibilities Curve Obviously, many businesses produce more than one type of product. An automobile company, for example, may manufacture several makes of cars per plant in a given year. What this means is that the company produces combinations of goods, which results in an opportunity cost.

     Economists use a model called the production possibilities curve to show the maximum combinations of goods and services that can be produced from a fixed amount of resources in a given period of time. This curve can help determine how much of each item to produce, thus revealing the trade-offs and opportunity costs involved in each decision.

   The classic example for explaining production possibilities in economics is the trade-off between spending on military defense and civilian goods, sometimes referred to as guns versus butter. The extreme situation for any nation would be to use all of its resources to produce only military goods or only civilian goods. Of course, in reality, nations always produce some of both. Governments, like businesses, face production possibilities curves all of the time, so they know they have to give up production of one type of good or service in order to get more production of another.

Unit 3