Definitions of factors of production: land, labour, capital and enterprise

Cambridge IGCSE Economics (0455) – The Basic Economic Problem & Factors of Production

Learning Objectives

• Explain the basic economic problem of scarcity and the three fundamental economic questions.
• Distinguish economic goods from free goods.
• Define the four factors of production – land, labour, capital and enterprise – and give relevant, up‑to‑date examples.
• State the reward each factor receives (rent, wages, interest, profit).
• Analyse how the quantity, quality and mobility of each factor affect production.
• Apply the concept of opportunity cost to production decisions (including a numeric illustration).
• Construct and interpret a Production Possibility Frontier (PPF) and explain how changes in the factors of production shift the curve.
• Use appropriate diagrams, terminology and evaluation in exam answers (AO1–AO3).

1. The Basic Economic Problem

1.1 Scarcity and the Three Fundamental Questions

• Scarcity: The world’s resources (land, labour, capital, enterprise, raw materials, etc.) are limited, while human wants are unlimited.
• Because of scarcity every society must answer three questions:
  1. What goods and services should be produced?
  2. How should they be produced (which techniques and which factors of production are used)?
  3. For whom are they produced (who receives the output)?
• These questions arise from the need to allocate scarce resources efficiently.
• Resources that are limited and satisfy wants are called economic goods (e.g., wheat, cars). Resources that are abundant and free (e.g., air, sunlight) are free goods.

1.2 Opportunity Cost (with numeric illustration)

• Definition: The value of the next best alternative that is foregone when a choice is made.
• Numeric example: One hectare of land can be used to produce either 100 tons of wheat or 50 tons of corn.
  • Opportunity cost of 1 ton of wheat = 0.5 ton of corn.
  • Opportunity cost of 1 ton of corn = 2 tons of wheat.
• Opportunity cost is the trade‑off shown by movement along a PPF.

1.3 Production Possibility Frontier (PPF)

1.3.1 Constructing a PPF

1. Select two goods the economy could produce (e.g., cars and wheat).
2. Place one good on the vertical axis, the other on the horizontal axis.
3. Identify all combinations that can be produced using all resources efficiently – plot these points.
4. Connect the points with a smooth, bowed‑out curve (reflects increasing opportunity cost).

1.3.2 Interpreting the PPF

• On the curve: Efficient production – all factors fully employed.
• Inside the curve: Inefficient – some resources idle or mis‑allocated.
• Outside the curve: Unattainable with current resources/technology.
• Movement along the curve: Shows the opportunity cost of producing more of one good.

1.3.3 Shifts of the PPF

• Outward shift (economic growth): Increase in quantity or quality of any factor of production, or technological improvement.
  • More land (e.g., discovery of new oil fields).
  • Better‑educated or larger labour force.
  • Advanced capital (new machinery, better infrastructure).
  • More innovative entrepreneurs.
• Inward shift (contraction): Natural disaster, war, loss of skilled labour, depreciation of capital, etc.

1.3.4 Sample PPF Diagram (exam‑style)

2. Factors of Production

2.1 Definitions, Rewards, Quantity/Quality, Mobility & Examples

2.2 How the Factors Interact – Real‑World Example

Renewable‑energy farm (e.g., a wind‑farm)

1. Land: A coastal site with strong, consistent winds.
2. Labour: Engineers to design turbines, technicians for installation and maintenance, project managers.
3. Capital: Turbines (physical capital) and the financing package (financial capital) needed to purchase them.
4. Enterprise: The renewable‑energy company that organises the project, secures permits, takes the market risk and sells the electricity.

If any factor is insufficient – for instance, a shortage of skilled turbine technicians – the farm’s output (electricity) will fall, illustrating the inter‑dependence of the factors.

3. Opportunity Cost Revisited

• When resources are shifted from one use to another, the foregone output is the opportunity cost.
• In the wind‑farm example, using a plot of land for turbines means it cannot be used for agriculture; the opportunity cost is the value of the agricultural output that is sacrificed.

4. Production Possibility Frontier (PPF) – Summary

5. Quick Revision Table

6. Key Points to Remember

• Scarcity forces societies to answer the three fundamental questions (what, how, for whom) and to distinguish economic goods from free goods.
• All four factors of production are essential; a shortage of any one limits output.
• Each factor receives a distinct reward: rent, wages, interest, profit.
• The quantity, quality and mobility of each factor determine an economy’s productive capacity.
• Opportunity cost is the trade‑off shown by movement along a PPF.
• Improvements in any factor (or better technology) shift the PPF outward, indicating economic growth; adverse events cause an inward shift.
• In exam answers, label diagrams clearly, use correct terminology, and always link the diagram to the relevant factor(s) of production.

7. Assessment Tips (AO1–AO3)

• AO1 – Knowledge: Memorise definitions, rewards, examples and the three fundamental questions.
• AO2 – Understanding: Explain cause‑and‑effect relationships (e.g., “More skilled labour → higher productivity → outward PPF shift”).
• AO3 – Application & Evaluation: Use up‑to‑date real‑world examples (e.g., discovery of offshore wind resources) and discuss short‑run vs. long‑run effects, trade‑offs, and possible unintended consequences.
• When drawing a PPF, always:
  1. Label the axes with the two goods.
  2. Show a point on the curve, a point inside and a point outside.
  3. Indicate movement along the curve (opportunity cost) and a shift (label the factor causing the shift).