What Is Factor Income? Definition and vs. Non-Factor Income

What Is Factor Income?

Factor income is the flow of income that is derived from the factors of production—the general inputs required to produce goods and services.

Factor income on the use of land is called rent, income generated from labor is called wages, and income generated from capital is called profit. The factor income of all normal residents of a country is referred to as the national income, while factor income and current transfers together are referred to as private income.

How Factor Income Is Used

Factor income is most commonly used in macroeconomic analysis, helping governments to determine the difference between gross domestic product (GDP), the monetary value of all the finished goods and services produced within a country's borders in a specific time period, and gross national product (GNP), the market value of all the final products and services turned out in a given period by a country’s residents. In other words, governments want to know how much income is generated domestically and how much income is generated by citizens abroad.

For most countries, the difference between GDP and GNP is small, since the income generated by citizens abroad and by foreigners domestically often offset each other. A large difference in factor income is more likely to be found in small, developing nations, where a significant portion of income may be generated by foreign direct investment (FDI).

The proportional distribution of factor income across the factors of production is also important in country-level analysis. Countries with low populations but great mineral wealth may see a low proportion of factor income stemming from labor, but a high proportion stemming from capital. Meanwhile, nations focusing on agriculture might experience an uptick in factor income derived from land, though crop failures or declining prices may lead to decreases. 

Special Considerations

Examining factor income can be a way to understand the causes behind periods of inequality in income distribution. For example, if a country experiences a rapid advance in technology followed by a move into industrialization, the balance of factor income will shift, at least for a time, away from labor and more toward capital. This is especially pronounced if the country had a long-term reliance on traditional labor to provide private income.

The introduction of technology that does not utilize such labor, or only partially relies on it, means that capital investments into the technology may escalate drastically. As those older forms of labor are phased out, there would be widening income inequality. 

Wages might decrease significantly for labor during such a transition. Over time, the populace may shift to generate personal income through opportunities in industrialization; however, there will likely be a period wherein only a select portion of the populace will be in a position to tap into the capital that is generated. The degree of change that industrialization brings can have a direct effect on factor income shifts.