Resources or Factors of Production

Land Capital
All naturally occurring resources Human made resources that can
(renewable & non renewable) which be used to create further G&S
are available for economic use

Enterprise
Risk takers who have the ability to
Labour initiate and manage the process of
Mental and physical human combining land, labour and capital to
input. Both the number of make a profit .
workers and their level of skills
measure the labour resource
 Introduction
•Factor pricing means the price paid for the services
rendered by the factor of production but not the price of
the factor itself.
•As goods are produced through the combined efforts of
the factors of production, the income earned through sale
of products or remuneration for services is distributed
among the four factors of production.
•Theories of factor pricing suggest the ways to distribute
the income among the factors of production.
•The process of income distribution can be done in two
ways. They are: personal distribution and functional
distribution.
• Personal Distribution: In this form of income distribution,
the national income of a country is distributed among the
owners of various factors of production such as rent for
land rented, wages for labor, interest on the capital
invested, and profit for entrepreneurship. Thus, the pattern
of individual income generation is studied under personal
distribution.
• Functional Distribution: Functional distribution of income
distribution deals with the distribution of income among
the four factors of production - land, labor, capital, and the
entrepreneur.
• It lays emphasis on the sources of income for factors of
production such as rent for land, wages for labor, interest
for capital, and profit for entrepreneur.
• There are two theories for functional income distribution.
They are the macro theory of distribution and micro theory
of distribution (Theory of factor pricing).
 MEANING OF RENT
• Rent can be termed as the reward for land which is one of the four
factors of production. For economists, the term 'land' indicates
natural resources like ground water, forests, rivers, oil fields, mineral
deposits, etc., apart from the physical soil.
• Since land is a natural product and cannot be reproduced, the
supply of land is permanently fixed and in general perfectly inelastic.
Usually the term rent refers to the payment made to the owner of the
factor to use the same for a specific period of time.
• Here, the term land includes any material asset which has a fixed
supply. For instance, payment made to use a house, vehicle, or
machine is termed as rent.
• However, economists term it as 'contract rent' as it includes return
on capital invested in material assets. 'Economic rent' is the term used
by economists to refer to the payment made for usage of land.
Scarcity Rent :
•According to modem theory of factor pricing, the scarcity of land
acted as the basis for the concept of rent. According to the theory,
rent would arise even if all lands are of equal quality.
•The modem theory further suggested that rent does not
determine price but is determined by price i.e., when the prices
are high, high rent is charged and not vice-versa.
 CONCEPT OF WAGES
• Labor is one of the four factors of production. In economics, the term
labor refers to both physical and mental work.
• Wage is the remuneration paid for labor. Payment of wages can be
done in different modes such as time wages, piece wages, task
wages, cash wages, kind wages and service wages.
• Time wages are the wages which are paid on the basis on number of
hours worked.
• Piece wages are the wages which are paid depending on the quantity
of output produced.
• Task wages are the wages which consider accomplishment of a task
for payment of wages.
• Cash wages are the wages which are paid in money form.
• Kind wages are the wages which are paid in the form of commodities.
• Service wages are the wages which are paid through a return service
for the service rendered.
 DISTINCTION BETWEEN REAL WAGES AND NOMINAL WAGES
• Apart from the different types of wages we have discussed till now, wages can
also be classified on the economic basis into nominal wages and real wages. The
value of wages earned by a worker is different in terms of nominal wages and real
wages.
• Real Wages: Organizations provide various facilities to workers apart from paying
salaries. The additional facilities such as transportation facilities, medical facilities,
accommodation, and other allowances paid in addition to the salary constitute
the real wages of workers.
• “Real wages or real earnings refer to the purchasing power of the worker's
remuneration i.e., the amount of necessaries, comforts and luxuries which the
worker can command in return for his services."
• If the money earned by a worker is Rs. 10,000 per month, his/her nominal wage is
Rs. 10,000 but the real wage refers to the purchasing power of the money earned
i.e., how much the worker can purchase with Rs. 10,000.
• Real wages serve as indicators with regard to the prosperity level of workers. If
the purchasing power of money is high, real wages are considered to be high.
• Smith, a renowned economist, stated that the laborer is rich or poor, is well or ill-
rewarded in proportion to the real, not the nominal, wages of his labor.
• Nominal Wages: According to Prof. Thomas, "nominal wages or
nominal earnings refer to the amount of the wages as measured in
terms of money.“
• Nominal wages are also known as money wages and refers to the
payment to a worker for the service rendered in terms of money. For
instance, if an amount of Rs.I0,000 is credited to a worker's bank
account as a salary for a month that amount is referred as the nominal
wage of the worker.
• Production of goods is not complete without the combined efforts of
all factors of production. Hence, successful management of business is
dependent on the successful management of all the factors of
production.
• The reward for land is rent, whereas the reward for labor is called
wages. In this chapter, we will discuss about the remaining two factors
of production namely, capital and organization or the entrepreneur.
• The reward for capital is known as interest and the reward for
entrepreneurship is known as profit.
• Therefore, an entrepreneur is concerned with the interest rates
because interest rates will have an impact on his business.
• For instance, an increase in interest rates would cause the
entrepreneur to lower his capital requirements, and this in turn
would have an impact on the production process.
• An entrepreneur uses his entrepreneurial abilities and manages all
the factors of production. In this way, he successfully accomplishes
the task of producing goods.
• He further makes efforts to sell these finished goods in the market.
The reward he gets for all these efforts is known as profit.
• Profits motivate entrepreneurs to improve their efforts and thereby
improve the production process.
• Thus, profits have an impact on business practices. Therefore, an
understanding of interest and profit are crucial for the successful
management of business.
• Hence, the rewards for capital and entrepreneurship are of great
importance to an 'entrepreneur'
 INTEREST
• What is Interest?
• The reward for capital is known as interest. The owner of the capital receives
interest for lending his/her capital to others.
• Capital can be classified into two types – fixed capital and variable capital. In
fact, when we say capital, it includes both fixed and variable capital.
• However, interest is the income earned only on the variable capital. Interest is
earned only on that portion of capital which is given by the owner to the
borrower.
• In other words, it is the price paid by the borrower to the lender who parted
with his money.
• Why do people get paid for lending their money? Money in the form of cash
provides the holder with benefit because it enables him to buy anything that he
desires.
• However, if an individual lends it to another person, then he will have to wait
until he gets back his money and only then he can utilize it.
• According to John Maynard Keynes, "Interest is a reward for parting with
liquidity for a specified period."
 Basic Concepts
• Gross interest: When the borrower pays an amount to the lender
for borrowing the lender's money, the amount so paid by the
borrower is known as 'interest'.
• Therefore, when people refer to interest, they generally refer to
'gross interest'. Gross interest is the total amount paid by the
borrower to the lender of the money.
• Net interest: Net interest is the amount paid to 'capitalists' only for
the use of 'capital'. It is the reward paid to the capitalists
exclusively for the use of capital.
• Net interest is the compensation for lending capital to others under
conditions where there is no risk or inconvenience due to
investment (investments made with no savings motive) and the
lender is not required to perform any work other than lending his
money.
• Therefore, net interest is a part of the gross interest. Gross interest
consists of some charges along with the net interest.
• Gross Interest = Price of the Capital (Net Interest) + Reward
for taking risk of money lending + Reward for management of
loan + Others (such as the reward for accepting the
inconveniences involved in money lending).
• Gross interest thus includes compensation for loan of capital,
compensation to cover risk of loss (either business risk or
personal risk), compensation for inconvenience of investment,
compensation for work and apprehension related to
monitoring investment.
• Saving and investment: According to the theory, savings and
investment are not interdependent. It is known that the
income level changes along with the changes in investments.
• The changes in investment levels invariably have an impact on
the savings of individuals. Therefore, it is not correct to say
that saving and investment are independent of each other.