Basic Economic Activities: Production and Factors of Production (For CBSE, ICSE, IAS, NET, NRA 2022)

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  • Basic economic activities of an economy is Production, consumption and capital formation. Scarce resources are used in the production of goods and services with the objective of satisfying our needs and wants. The process of production of goods and services is carried by combining the factors like land, labour, capital and entrepreneurship.
  • Factors are paid rent, wages, interest and profits for their productive services. The consumption activity consists of the use of goods and services for the direct satisfaction of individual or collective human wants. A part of current production is saved for future to add to existing capital stock like, plant, machinery, building etc. every year in order to expand production potential in future. So, whatever is produced is disposed of either for consumption or for capital formation or both.

Production

Production is defined as creation of utility. The goal of production is to satisfy our wants. These goods and services produced can be sold in markets or can be provided by the government to public at nominal charge. People who make and sell these goods and services are known as producers. The producers combine the factors like land, labour, capital and entrepreneurship along with raw materials in order to transform them into various goods and services. Land, labour, capital and entrepreneurship are called the factors of production.

Factors of Production

  • Land: Land is a gift of nature. It includes plain region, mountains and plateau region. The plain region is useful for agriculture and industrial activities. Production of food grains, vegetables, fruits etc require agricultural land in the plan region. Along with this people also carry out animal husbandry, fisheries and forestry which are called allied activities. In India rural area is known for carrying out agricultural and allied activities.
  • Labour: In general, labour implies the human effort through physical and mental exertions in the production of goods and services. Production activities require both skilled and unskilled labour. A person working on the agricultural field is said to provide his physical labour while a writer of a book is said to provide his mental labour. People who provide labour are known as human resources.
  • Capital: By capital, we mean all man-made appliances and all types of wealth used in production. Capital consists of machinery, tools, buildings, materials etc. capital is a passive factor of production and cannot be used without employing labour to work. Capital has a limited span of life and becomes obsolete after a certain period. Small tools like, screwdrivers, calculators to heavy machines like engines, tractors, ships are all examples of fixed capital, as they can be used in production for many years. The working capital includes raw materials like cotton yarn, clay, seeds, fertilizers, which are used up in the process of production.
  • Entrepreneurship: Entrepreneurship is the art of organizing the production activity. The person who makes the decisions and controls the production process and bears the risks and uncertainties involved in production is called an entrepreneur. He/she should be knowledgeable, courageous and should possess leadership qualities. The objective of an entrepreneur is to get maximum production by using the given resources and make arrangements for the sale of the finished products. He/she is also responsible to make payments to other factors of production. He/she pays wages to the labourers, rent to the landlords and interest to the owner of capital in return for their productive services. Similarly, they earn profit for their productive activity. Since these payments, rent, wages, interest and profits are received by the factors for their productive services, they are termed as factor incomes.

Factor Incomes

These factors of production are owned by people. Land is owned by the landlord, labour is owned by labourer, capital is owned by people who acquire capital goods, entrepreneurship is owned by the entrepreneur. The owners of factors of production are paid in return for their productive services. When you hire a piece of land, you pay rent to the landlord for using the services of land. Thus, the tenant pays rent for the services of land. Labour refers to the services rendered by the workers. It refers to all types of workers, manual labour, technical workers and so on. When an employer requires the services rendered by a worker, he/she is ready to pay for his services. By hiring a worker, actually his services are hired. When a loan is taken from a bank to buy a tractor, seeds, machinery etc. interest is paid to bank. Thus, rent is paid to the landlords, wages to the labourers, interest to the owners of capital resources and profit to the entrepreneurs. Since they are paid in return to their productive services, they are called factor payments and their incomes are called factor incomes.

Consumption

  • The consumption activity consists of the use of goods and services for the direct satisfaction of individual or collective human wants or needs. To satisfy their wants the households purchase a large variety of goods and services.
  • Example for Goods- cycles, furniture, television set, car, refrigerator, food grains etc.
  • Example for services - barber, teacher, doctor, bank and insurance companies etc.

Capital Formation

Capital formation is done by refraining from present consumption. It should be noted that saving, if kept idle, cannot constitute capital formation. If a person saves money and locks up in the house, no capital formation takes place. If only the saved money is invested in capital goods it leads to capital formation by facilitating production and consumption in future. Thus, current consumption is forgone and used towards adding to existing capital stock like, plant, machinery, building etc. every year in order to expand production potential in future. This increase in the stock of capital goods in a year is called capital formation or investment.

Capital Formation

These three activities, production, consumption and capital formation are interrelated. An increase in the production of goods and services increases the level of consumption and capital formation. Increase in consumption is an indicator of rising standard of living of people and increase in capital formation is very important as the growth of the country depends on it. More consumption is possible if there is more production and more production is possible if there is more capital formation.

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