Wednesday, December 22, 2010


There will be a quiz at the end.

"The Factors of Production"

The following table lists a few textbooks, showing the page number where the factors of production are discussed, and a snippet of discussion.

Date Title Author Page Excerpt
1958 Economics Paul A. Samuelson 575 "Our traditional account of capital theory begins with a rather arbitrary division of all productive factors into three categories"
1969 Economics Richard G. Lipsey &
Peter O. Steiner
380 "Producers require land, labor, raw materials, machines, and other factors of production because these are needed to produce the goods and services that the firm sells."
1975 Economics Campbell R. McConnell N/A N/A
1988 Economics Edwin G. Dolan &
David E. Lindsey
698 "Factor markets are important in determining how goods and services are produced"
2000 Macroeconomics N. Gregory Mankiw 44 "Factors of production are the inputs used to produce goods and services"
2001 Economics William J. Baumol &
Alan S. Blinder
330 "Factors of production are the broad categories ... into which we divide the economy's different productive inputs"

I find it strange that the factors are typically not introduced early in these textbooks. I find it even more odd that none of these textbook authors are inclined to stress the importance of cost as the reason to have factor categories. (I include the 1975 book on the list because that's the book we used in the macro course I took.)

The importance of the factors of production does not arise from the fact that they are "arbitrary divisions," nor because they are "broad categories."

The factors are important because they are used in the production of goods and services, as some of the textbooks note. But they are not important because they "are needed to produce the goods and services that the firm sells." The factors are important because they are the components of cost. Adam Smith writes:

In every society the price of every commodity finally resolves itself into some one or other, or all of those three parts; and in every improved society, all three enter more or less, as component parts, into the price of the far greater part of commodities.

The factors of production are cost categories. Adam Smith identified three categories: land, labor, and capital. With each category he associated a cost: rent, wages, and profits. The factors are important because they allow us to analyze economic performance in terms of cost.

Today, cost is divided between wages and profit, with some to rent, and much to a fourth factor that was less significant in Smith's time: the cost of interest.

The economy is composed entirely of transactions. In every transaction, cost is a consideration; often it is the most important consideration. This is the reason that factor costs are important. And that is why the factors of production are important.

Because the economy consists of transactions, because transactions always occur at the intersection of cost and price, and because cost is always the limiting factor -- we are always willing to accept more in payment, but we are not always willing to pay more -- cost is the most significant of all of economic forces.

I am not satisfied that economists are aware of the significance of cost either in regard to our economy in general, or to the factors in particular. Reviewing the snippets in the above table, it is not clear that any of the textbook authors are even vaguely aware cost is the central concern that gives importance to the factors of production.

QUIZ, as promised:

Q: What is the most significant of all of economic forces?

A: Cost.

Q: What has the most influence on economic performance?

A: Cost.

Q: What is the limiting factor in every transaction?

A: Cost.

Q: What gives importance to the factors of production?

A: Cost.

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