Why, in economic terms, is money not a factor of production? An entrepreneur needs money to start a business, right?
Why, in economic terms, is money not a factor of production?
An entrepreneur needs money to start a business, right?
To answer this, let’s start by pointing out that the contrary point is, in fact, wrong. An entrepreneur does not “need” money. She needs physical resources, human labor, equipment, and techniques of production. This holds true regardless of whether the thing produced is a physical object or a service performed. The degree to which these resources are required varies widely. In classical economic analysis, these are referred to as “land, labor, and capital,” primarily because early work focused on agriculture as the source of all wealth creation.
There is no reason why, hypothetically, a group of people could not agree to get together and contribute the necessary resources to form a firm and produce and market a good or service. There is also no reason why they could not agree with their customers to receive payment in the form of other goods and services produced by those customers. The people who contributed their resources to the entrepreneur’s firm would have to come up with some method for dividing the goods and services received from the customers to compensate them for the resources, time, and ideas they contributed. The whole system works to create and distribute things and services of value, and all without money. This is referred to as a barter system.
In practice, barter systems are terribly inefficient. Under barter, it is difficult to (a) divide an item offered in payment among the various people who need to be compensated, and (b) manage payments over expanses of space and time. Bartering also leads to problems of valuing the items being bartered (e.g. the cow I offer in payment may be much larger or produce more milk than the one you offer). Money is used to solve these problems. It serves as a medium of exchange, a way to place a numerical value on what is being traded, and a store of value over time. In and of itself, it is not “used” to produce anything.
In economic terms, money is not a factor of production because it is a resource used to acquire resources that go into producing goods. The factors of production are capital, labor, and land.
Money is needed to start a business as the questioner rightly asserts. However, it is not a factor of production. Money is used to purchase or pay for (in the case of labor) factors of production.
Capital is used to create goods or services and can make workers more productive in the manufacturing process. For example an immense piece of machinery that bends steel into shape in a car manufacturing plant is an example of a physical asset or product that was built to be used in the manufacturing process. Money was needed to buy the machine, but it is not a factor in the actual production.
Labor is the work that people perform during the production process. Laborers expend their physical, emotional, intellectual, and mental resources in the production process. They are paid a wage or salary for their efforts. However, money is not a factor of the production they are doing. Money is their payment for engaging in a factor of production.
Land is a factor of production that is not used up. It is essential to the production process because without land there is no place to have a manufacturing facility, head office, and such. Land is a fixed asset on a company’s balance sheet. Land is required as the starting point for the production process. Money is used to purchase or rent land. Nonetheless, this money is not part of the actual production process once a company is up and running.
In economics, the term "factor of production" is used interchangeably with the term "resource." There are three kinds of factors of production -- land, labor, and capital (some economists say entrepreneurship is a fourth). Money is not a factor of production and here's why:
- A factor of production is defined as an input that is used to make a good or a service.
- Money can not be made into a good or service (the only exception to this that I know is in Hawaii where sometimes they make dollar bills into leis for graduations and such).
- Instead, money can only be used to buy things that really are factors of production.
So in response to your secondary question, an entrepreneur does need money to start a business, but the money itself is no use unless he/she can buy things that will actually be used to provide a good or service.