Meaning of Production and Factors of Production

Production is the process of creating goods and services by combining various inputs, called factors of production, to satisfy human wants. In economics, production is not limited to the physical manufacture of a tangible good such as cloth or furniture — it equally includes the creation of a service, such as teaching, banking or transport, since a service is just as capable of satisfying a want even though nothing physical is produced. Whatever is produced, it is produced only because some collection of resources was organised and combined for that purpose; the study of HOW inputs are converted into output, and in what quantities, is the subject matter of production analysis.

Economics classifies every resource used in production under one of four broad heads, called the factors of production:

• Land: the free gift of nature — not just the surface soil but every natural resource used in production (minerals, water, forests, climate, and location itself). Land is fixed in total supply for a country and has no cost of production of its own; the payment it earns is called rent.
• Labour: the physical and mental effort of human beings applied to production. Unlike land, labour is inseparable from the labourer supplying it — it cannot be stored or used apart from the person providing it. The payment labour earns is called wages.
• Capital: any produced (man-made) input used to produce further goods and services — machinery, tools, buildings, and the money capital that finances their purchase. Unlike land, capital is not a free gift of nature; it must itself be produced by combining land and labour, and it earns interest.
• Organisation (Entrepreneurship): the fourth factor, which brings the other three together, decides what and how much to produce, and bears the risk and uncertainty of the business. It takes the residual reward left over after land, labour and capital have all been paid — called profit. Unlike the other three factors, the entrepreneur's reward is not contractually fixed in advance; it can be positive, zero, or even negative (a loss).

These four factors are combined in different proportions to produce every good and service in the economy, and the technical relationship between the quantities of factors used and the quantity of output obtained is what the production function, discussed next, formally describes.