CHAPTER 3

MEANING OF PRODUCTION AND FACTORS OF PRODUCTION

SYNOPSIS
 Nature of production and types of production?
 Factors of production.(land, labor, capital and entrepreneurship)
 Characteristics of each factor of production.

I. NATURE OF PRODUCTION AND TYPES OF PRODUCTION.

i) NATURE OF PRODUCTION.
 Production implies the making of a commodity or the supplying of a service.
 It is very different form creation.
 As the saying goes “God creates but man produces”
 Creation implies the production of something out of nothing.
 Production on the other hand refers to the making of a commodity or service out of
something else.
 EG: Man takes out coal from the earth; the extraction of coal is production. Man does
not produce the coal as nature as produced it. A carpenter produces a chair or a table
from wood; but he does not make wood which is actually a product of nature.
ii) TYPES OF PRODUCTION
 Production as cultivation: Production may take the form of cultivation. E.g.: the
farmer plows, sows, irrigates, weeds and finally as the end harvests his crop say
wheat.
 Production as extraction: Production may also take the form of taking out certain
goods which are already made by nature. E.g.: The coal from the earth and fish from
the sea.
 Production as manufacturing: Production may take the form of changing one
commodity into another. E.g.: the production of a table from wood.
 Production as distribution: Production takes place when a commodity is stored over
time or when it is shifted from one place to another till it reaches the consumer.

II. FACTORS OF PRODUCTION

 Factors or agents of production refer to those goods or services without which

production is not possible.
 E.g.: paper, printing press, labor, land, bullocks, plough, seeds, tools etc are all
factors of production.
 They are called factors of production because they help in the production of goods.
 Generally we speak of four main factors namely: Land, labor, capital and
entrepreneurship.
i.) Land.
 Ordinarily when we speak of land, we refer to the space upon which we build our
homes, farms and factories.
 In economics we speak of land as a factor of production and hence we refer to not
only the soil but all the natural resources which we find on the ground, beneath the
ground in the water and in the air.
 Land therefore refers to all natural resources- the materials and the forces which
nature gives freely for aid in land and water, in air, light and heat.
 Natural resources may be defined as all those gifts of nature which man uses to
produce goods and services which satisfy his wants.
 Land refers to the sea, lakes, river valleys, mountains plains etc. on which depends
the prosperity and wealth of the country.
 Thus natural resources or land constitute an important factor production.
 A country which is blessed with plenty of natural resources can become rich and
prosperous.
 However one must realize that resources are useless unless man is prepared to use
them and has the necessary knowledge and ability to use them.

 The following are the characteristics of Land:

a)Land is a free gift of nature

 It is not a produced or man-mad agent.
 It follows therefore that we have to accept it as it is.
 No doubt that man tries sot improve and modify nature but he cannot comp[lately
master it.
 A poor soil and a bad climate are great handicaps in the way of industrial and
commercial prosperity.

b) Land is limited in area

 Efforts have been made to reclaim land from eh sea, and thus add to the total land
surface.
 These efforts have produced only negligible results as compared with the total area
already in existence.
 Some land in Holland has been reclaimed from the sea but it is after all a small
percentage of the total land surface of the world.

c) Land is not perishable/It is permanent.
 It is not easy to destroy it. Al other factors are destructible but land cannot be
completely destroyed.
 Even the havoc caused by a drought, by an atom bomb etc can be cured and natural
powers restored after some time.

d) Land lacks mobility.

 Land cannot be moved bodily from one place to another.
 It lacks geographical mobility but it can be put to many alternative uses ans is thus
mobiles from a different point of view.
e) Land is of infinite variety/ Land varies in quality.
 Land is not man-made. Nature has so made it that different pieces of land present,
infinite variations.
 None can say where the sandy soil ends and the clay begins.
 One type shades into another.
 Such minute variations are not found in any other factor of production.
 Besides the situation of different pieces of land also varies.

f) Land differs in location

 Land differs in the matter of location.
 Land in large cities like Delhi, Bombay and Calcutta is extremely scarce and hence
commands a high value.
 E.g.: Land located in a river valley is likely to be more productive and richer than
land located on a mountain slope.

ii.) Labor
 In ordinary language, labor refers to the work done manually or it refer to the workers
who use their hands and feet.
 In economics the term labor refers to “ the inclusion of all efforts made by mad to
earn a living”
 If a person uses his energy and exerts his mind and body with the motive of getting an
income, he is engaged in labor.
 Hence labor is defined as

“any effort physical or mental made to earn a living”

 The following are the characteristics of Labor:

a. The worker and his services go together.

 Labor is clearly different from all other factors of production.
 The worker embodies the service which he performs. He is not distinct and separate
from his own service.
 On the other hand, all other suppliers of factories are distance and separate from the
factors which they supply.
 E.g: the capitalist is different from the land which he owns but the worker and his
services go together.

b. The worker sells only his services.

 Whatever has been spent on laborers training cannot be recovered by selling his labor.
 That might have been possible when slave trade used to flourish.
 But those days are long gone and now investment in the laborer becomes a part and
parcel of him.
c. Labor is perishable.
 If time flies, the laborer also fliers with it.
 A day lost without work means a days work gone for ever.
 That is why workers are compelled to accept even low wages rather than earn
nothing.

d. The worker cannot separate himself from the services.

 A farmer who produces cotton may send his produce to a nearby market or to a
distant market but he himself need not go to the market.
 The textile mill which produces cloth may sell within the country or elsewhere but
neither the mill not its representative need go to all the markets where the cloth is
sold.
 This is the case with all factors.
 But in the case of labor, the worker has to present himself and offer his services
personally.
 This is so because the laborers services and the laborer himself are inseparable.

e. Wages alone do not influence labor

 Because of the personal nature of labour service, wages alone are not significant.
 Other considerations such as the number of hours worked, the relative security of
working conditions, pensions, vacations etc are equally important in influencing
people to come for work.

f. Supply of labor is peculiar.

 Generally the supply of a commodity changes directly with price; the higher the price
the higher its supply and lower the price, the smaller the quantity supplied.
 In the case of supply of labour, however the position is different.
 If wages rise the supply of labour may contract and if wages fall the supply of labour
may increase.

g. Supply of labor changes slowly.

 If there is more demand for cloth, the manufactures will produce more and sell more.
 On the other hand if demand for cloth declines, the manufacturers will cut down their
production of cloth.
 In other words production and supply of goods are adjusted according to demand.
 This is not so in the case of labour.
 If the demand for labor in general increases and if the number of workers is small in
the country, it will take a long time say 20 to 30 years to increase the number.
 Suppose the demand for a particular type of labor is increased, say that of engineers
and doctors , it would take some years to produce and train the workers in such tasks.
 Thus the supply of labour changes slowly.

h. Labor is mobile but labor mobility is low.

 Labor is much less mobile than capital and other goods.
 This follows from the fact that a laborer is not a machine.
 He does not want to leave his heart, his home or his children
 A few other minor characteristics are- Man is not a machine, Difficulty of
calculating cost of production, Labour differ in efficiency and laborer do not have
the same power of bargaining as their employers.

iii.)Capital
 Generally when we speak of capital we refer to it as money but in economics the term
capital is used in a much wider sense.
 It refers to all man made goods which are used in production.
 They are also known as producer’s goods or capital goods.
 Capital includes tools, equipments, machinery, buildings, transport equipment, raw
materials etc.
 All these goods are regarded as wealth but they will be capital provided that they are
used in production.
 Thus capital is wealth but wealth is not capital.

 The are two types of capital that we speak of:-

a. Constant or Fixed Capital
b. Variable or Circulating Capital

a. Constant or Fixed Capital

 It refers to the initial investment in installed capacity that is investment in buildings,
machines, tools etc.
 The fixed cost of a firm remains fixed irrespective of level of output production,
whether the firm produces of units of output or infinite units of output, the fixed cost
remains the same.

b. Variable or Circulating Capital

 Variable cost is that cost which varies with the level of output.
 Lesser the production, lower the variable cost and larger the production higher the
variable cost.
 Variable cost examples: raw material costs, taxes etc.
 The following are the characteristics of capital are:

a. Capital is man-made- it is not a gift of nature.

 Capital is generally defined as that part of wealth which is used in the further
production of wealth.
 It consists of all types of tools, implements, machinery, buildings, raw materials etc.
 Hence capital is man-made.
b. Capital is not fixed in quantity and can be increased and decreased.
 Capital Depreciation
 Capital Formation
 Meaning: Capital formation means increasing the stock of real capital in a country. In
other words, capital formation involves the making of more capital goods such as
machines, tools, factories, transport equipment, materials, electricity, etc which are all
used for further production of goods. For making additions to the stock of capital,
savings and investment are essential.
 There are three steps in capital formation:
i. Restructure in consumption and increase in savings.
ii. The existence of banks and financial institutes to mobilize the savings of the general
public and enable them to invest it.
iii. The existence of enterprise or investment opportunities.
c. Capital is perishable
 Capital of every type has a limited life or limited life-span
 Over a period of time capital equipment will be deprecate and becomes useless or
breaks down.
 Thus capital can be destroyed or it is perishable.
d. Capital is mobile
 Readiness of capital to move from one place to another or one country to another.
 The possibility of pitting any capital equipment to alternative uses.
 Mobility of capital is influenced or determined by the rate of interest.
 Capital moves from low interest places, areas occupation, uses to high interest.
 So the rate of interest in the main cause of capital mobility.
e. Capital in each group is identical or homogeneous.
 Capital in each group is identical or homogeneous.
 E.g: In a factory, where sowing machines are produced each sowing machine is
exactly the same or identical in all respects.

iv.) Entrepreneurship.
 In the past production was carried on in the house of workers or in small workshops.
 The worker in olden times himself possessed the tools he required supplied the capital
he wanted, owned his own land or house, and planned the operation himself.
 He was the landlord, the worker, the capitalist and the organizer al rolled in one.
 But conditions of production and market have changed considerable these days.
Production is no more simple.
 It is organized on a large scale and had become highly complex.
 Besides factors of production are owned separately and sometime may even lie
scattered.
 A cotton textile mill in Coimbatore engages over 5000 workers who come from all
over Tamil Naidu and Kerela, Its capital is supplied by shareholders, spread over the
whole of India but also in other countries.

 It becomes, necessary therefore for someone to bring all the factors of production
together, co-ordinate them, supervise and manage them.
 Such a person, or often a group of persons known as the organizer or the enterpriser
of entrepreneur.
 “Entrepreneur” is a French Word which is now commonly used by economists to
refer to the person or persons who perform the task of organizing and managing a
business.

 The functions of an entrepreneur are therefore:

a. He decides about what he will produce, where he will produce and how he will
produce it.
b. He co0ordiantes the work of the different factors of production.
c. He anticipates the future demand and future prices.
d. He introduces a new idea or a new commodity, a new process or some new
machinery.
e. He busy raw material and sells the finished goods.
f. He represents the business before the government or with other enterprises.

 Conclusion
 In short he is the one who must take all the decisions regarding the organization
running and management of the firm.
 In performing these functions the organizer assumes many risks and bears a heavy
responsibility.
 The entrepreneur is not a paid manager. He is the one who acts as boss and who
decides as to how the business should be run; he is not paid any fixed wages. \
 The entrepreneur himself is not employed by anyone and is not paid a fixed salary.

LAW OF VARIABLE PROPORTIONS

The law of variable proportions states that as the quantity of one factor is increased, keeping the
other factors fixed, the marginal product of that factor will eventually decline. This means that
upto the use of a certain amount of variable factor, marginal product of the factor may increase
and after a certain stage it starts diminishing. When the variable factor becomes relatively
abundant, the marginal product may become negative.
Assumptions: The law of variable proportions holds good under the following conditions:

1. Constant State of Technology: First, the state of technology is assumed to be given

and unchanged. If there is improvement in the technology, then the marginal product may rise
instead of diminishing.
2. Fixed Amount of Other Factors: Secondly, there must be some inputs whose quantity is
kept fixed. It is only in this way that we can alter the factor proportions and know its effects on
output. The law does not apply if all factors are proportionately varied.
3. Possibility of Varying the Factor proportions: Thirdly, the law is based upon the
possibility of varying the proportions in which the various factors can be combined to produce
a product. The law does not apply if the factors must be used in fixed proportions to yield a
product.

Illustration of the Law: The law of variable proportion is illustrated in the following table and
figure. Suppose there is a given amount of land in which more and more labour (variable
factor) is used to produce wheat.

Units of Labour Total Product Marginal Product Average Product

1 2 2 2
2 6 4 3

3 12 6 4

4 16 4 4

5 18 2 3.6

6 18 0 3

7 14 -4 2

8 8 -6 1
It can be seen from the table that upto the use of 3 units of labour, total product increases at an
increasing rate and beyond the third unit total product increases at a diminishing rate. This fact is
shown by the marginal product which is the addition made to Total Product as a result of
increasing the variable factor i.e. labour.
It can be seen from the table that the marginal product of labour initially rises and beyond the use
of three units of labour, it starts diminishing. The use of six units of labour does not add anything
to the total production of wheat. Hence, the marginal product of labour has fallen to zero. Beyond
the use of six units of labour, total product diminishes and therefore marginal product of labour
becomes negative. Regarding the average product of labour, it rises up to the use of third unit of
labour and beyond that it is falling throughout.
Three Stages of the Law of Variable Proportions: These stages are illustrated in the following
figure where labour is measured on the X-axis and output on the Y-axis.
Stage 1. Stage of Increasing Returns: In this stage, total product increases at an increasing
rate up to a point. This is because the efficiency of the fixed factors increases as additional units
of the variable factors are added to it. In the figure, from the origin to the point F, slope of the total
product curve TP is increasing i.e. the curve TP is concave upwards upto the point F, which
means that the marginal product MP of labour rises. The point F where the total product stops
increasing at an increasing rate and starts increasing at a diminishing rate is called the point of
inflection. Corresponding vertically to this point of inflection marginal product of labour is
maximum, after which it diminishes. This stage is called the stage of increasing returns because
the average product of the variable factor increases throughout this stage. This stage ends at the
point where the average product curve reaches its highest point.
Stage 2. Stage of Diminishing Returns: In this stage, total product continues to increase but at
a diminishing rate until it reaches its maximum point H where the second stage ends. In this stage
both the marginal product and average product of labour are diminishing but are positive. This is
because the fixed factor becomes inadequate relative to the quantity of the variable factor. At the
end of the second stage, i.e., at point M marginal product of labour is zero which corresponds to
the maximum point H of the total product curve TP. This stage is important because the firm will
seek to produce in this range.
Stage 3. Stage of Negative Returns: In stage 3, total product declines and therefore the TP
curve slopes downward. As a result, marginal product of labour is negative and the MP curve falls
below the X-axis. In this stage the variable factor (labour) is too much relative to the fixed factor.
Importance and Applicability of the Law of Variable Proportion:
The Law of Variable Proportion has universal applicability in any branch of production. It forms
the basis of a number of doctrines in economics. The Malthusian theory of population stems from
the fact that food supply does not increase faster than the growth in population because of the
operation of the law of diminishing returns in agriculture.
Ricardo also based his theory of rent on this principle. According to him rent arises because the
operation of the law of diminishing return forces the application of additional doses of labour and
capital on a piece of land. Similarly the law of diminishing marginal utility and that of diminishing
marginal physical productivity in the theory of distribution are also based on this theory.
The law is of fundamental importance for understanding the problems of underdeveloped
countries. In such agricultural economies the pressure of population on land increases with the
increase in population. This leads to declining or even zero or negative marginal productivity of
workers. This explains the operation of the law of diminishing returns in LDCs in its intensive
form. Ragnar Nurkse have suggested ways to make use of these disguisedly unemployed labour
by withdrawing them and putting them in those occupations where the marginal productivity is
positive.