Productive Mechanism | ICSE Class 10 Economics Notes

This note covers the productive mechanism of an economy: the four factors of production and the reward each earns; how the mix of factors shapes the way an economy produces; land, its characteristics, productivity of land and the factors that affect it; labour, its characteristics, division of labour with its types and advantages, and efficiency of labour, including the reasons for low efficiency of Indian labour; capital, its characteristics, physical and financial capital, and capital formation with its process and need; and the entrepreneur's functions and role in economic development.

What are the factors of production?

Production is the process by which a firm turns inputs into output. The inputs that a firm uses in the production process are called factors of production. Resources used for production can be natural, like water and coal, or human-made, like capital and technology.

Four factors of production are studied here: land, labour, capital and the entrepreneur. Together they make up the productive mechanism of an economy.

What does each factor earn?

Each factor receives its own remuneration. Human labour earns a wage, capital earns interest, entrepreneurship earns profit, and the fixed natural resources, called land, earn rent.

A firm sells its output and earns revenue. Part of the revenue is paid as rent for the service of land, part as interest to capital and part as wages to labour. The rest is the earning of the entrepreneur, called profit.

Four illustrated panels surround a central label, Factors of Production. The Land panel shows crop fields, a river, hills and trees. The Labour panel shows a farmer standing between two bullocks, two women workers, a man working at a computer and a doctor. The Capital panel shows a factory with chimneys, machinery, a power transmission tower, a road and money bags marked with the rupee sign. The Technology panel shows a computer, robots, satellites, a drone and laboratory equipment.

Some textbooks list technology as a factor in place of the entrepreneur; in this syllabus the four factors are land, labour, capital and the entrepreneur, and technology works through them. Technology matters because it decides the maximum output that different combinations of inputs can produce; when technology improves, the same factors can produce more.

How do the factors of production shape the production structure of an economy?

Every economy must decide how to produce: which methods, resources and technologies to use. Producers must select the right mix of the factors of production. The methods an economy uses, and the sectors in which its workers are employed, make up its production structure.

What are labour-intensive and capital-intensive methods?

Production can be labour-intensive, using more workers and less machinery, or capital-intensive, using more machines and technology and fewer workers. Usually, agriculture and handicrafts rely more on labour, whereas industries such as steel and automobile manufacturing depend more on machinery.

If machines are expensive, a garment manufacturer relies more on labour; if machines become affordable, it may shift to automation. Laws and regulations, such as labour laws or incentives for machinery, also influence the decision.

How has the use of India's labour across sectors changed?

Development strategies in many countries, including India, have aimed at reducing the proportion of people depending on agriculture. The distribution of India's workforce shows a substantial shift from farm work to non-farm work.

Table: Distribution of India's workforce by sector (per cent)

What is land in economics, and what are its characteristics?

In economics, land is not just the surface of the earth. It covers all the natural resources, the free gifts of nature, used in production: soil, water, forests, minerals, sunlight and climate. Alfred Marshall described land as the materials and forces that nature gives freely, in land and water, in air and light and heat.

Ninety-five per cent of our basic needs for food, shelter and clothing are obtained from land.

What are the characteristics of land?

1. Free gift of nature: land is not made by people, although an individual buyer pays a price for a plot.
2. Limited in supply: land is an asset of a finite magnitude. The total geographical area of India, for example, is 3.28 million sq km. Human effort can improve land or change its use, but can hardly add to its total area.
3. Permanent: land as a surface is not used up in production, unlike a machine that wears out. Its fertility, however, can be lost through misuse.
4. Geographically immobile: land cannot be moved from one place to another, though it can be shifted from one use to another.
5. Passive factor: land produces nothing by itself. It becomes productive when labour and capital are applied to it.
6. Heterogeneous: plots differ in fertility and location. Alluvial soils as a whole are very fertile, while alluvial soils in drier areas are more alkaline and can be productive after proper treatment and irrigation.
7. Alternative uses: the same land can grow different crops or be put to non-agricultural uses such as settlements, roads, railways and industry.

How does limited land force a choice?

With limited land, water and labour, a farmer must decide how much of each crop to produce. Suppose a farmer can grow either barley or wheat on a piece of land.

Barley in kg is on the x-axis and wheat in kg on the y-axis, each marked from 0 to 100. Points A (0, 100), B (25, 90), C (50, 70), D (75, 40) and E (100, 0) are joined by a downward sloping curve that bows outwards, and the area under the curve is shaded.

Moving from A to E, the farmer produces more barley and less wheat. To grow more barley, some wheat must be sacrificed; the value of what is given up is the opportunity cost. All points on the curve show the maximum output possible through efficient use of resources.

What is productivity of land, and what affects it?

Productivity of land means the output that a given area of land yields in a given period, such as the tonnes of wheat harvested from one hectare in a season. A large farm may produce more in total and still be less productive per hectare than a small one.

Productivity of land = Total output ÷ Area of land cultivated

Worked example 1: comparing productivity of land. Farmer A cultivates 3 hectares and harvests 12 tonnes of wheat in a season. Farmer B cultivates 2 hectares and harvests 10 tonnes in the same season. Whose land is more productive, and by how much?

Working: A = 12 ÷ 3 = 4 tonnes per hectare. B = 10 ÷ 2 = 5 tonnes per hectare.

Answer: B's land is more productive by 1 tonne per hectare, or 25 per cent (1 ÷ 4 × 100), even though A's total output is larger.

Which factors affect the productivity of land?

1. Natural fertility of the soil: alluvial soils mostly contain adequate proportions of potash, phosphoric acid and lime, and due to their high fertility these regions are intensively cultivated.
2. Climate and rainfall: most farmers in large parts of the country still depend on the monsoon and natural fertility.
3. Irrigation: intensive farming uses high doses of biochemical inputs and irrigation to obtain higher production, while over-irrigation causes waterlogging and increases salinity and alkalinity in the soil.
4. Modern inputs: high yielding variety (HYV) seeds, chemical fertilisers, insecticides and pesticides are used to obtain higher productivity. In slash and burn farming, land productivity is low because the farmer does not use fertilisers or other modern inputs.
5. Size of holdings: the right of inheritance divides land among successive generations, which has made many holdings uneconomical and led to fragmentation.
6. Land reforms and ownership: consolidation of holdings and abolition of zamindari were given priority after Independence, and a cultivator who owns the land has more reason to improve it.
7. Care of land: deforestation, overgrazing and mining degrade land, and ploughing up and down the slope causes soil erosion. Contour ploughing, terrace cultivation and strip cropping check erosion.
8. Technology and skill: adequate education and training to farmers can raise productivity in farms.

Note: Fertility and productivity are not the same. Fertility is the natural ability of the soil to support plant growth, while productivity is the output actually obtained per unit area, which also depends on irrigation, inputs, methods and care of the land.

What is labour, and what are its characteristics?

In economics, labour means any human effort, physical or mental, undertaken in return for a reward, the wage. A farmer, a factory worker, an office worker and a doctor all supply labour.

All those engaged in economic activities, in whatever capacity, high or low, are workers, including the self-employed. During 2022-23, India had a workforce of about 545 million. Cooking at home is not an economic activity, because the food is not sold; the same cooking in a restaurant is.

What are the characteristics of labour?

1. Inseparable from the labourer: only the services of labour are sold, so the worker must be present where production takes place.
2. Perishable: labour cannot be stored. A working day on which a worker finds no work is lost.
3. Active factor: labour is a human factor that brings passive land and capital into use.
4. Less mobile than capital: movement of skilled people between countries is restricted by nationality and culture, while physical capital moves much more easily.
5. Weak bargaining power: an individual worker cannot hold back labour for long. A small section of workers, in the formal sector, forms trade unions and bargains with employers for better wages.
6. Differences in efficiency: the labour skill of an educated person is more than that of an uneducated person.
7. Supply changes slowly: the supply of labour depends on the size of the population, which cannot change quickly.

What happens when there are more workers than the work needs?

Take a small farmer, Laxmi, with about two hectares of unirrigated land. All five members of her family work on the plot throughout the year because they have nowhere else to go for work.

This is disguised unemployment: people are apparently working but work less than their potential, and two members could move to other work without affecting production.

What is division of labour, and what are its types and advantages?

Division of labour means dividing the work of production into separate occupations, processes or operations, each given to a different worker or group of workers who specialise in it. Each worker does one part of the job repeatedly instead of making the whole product.

How did Adam Smith explain division of labour?

Adam Smith, regarded as the founding father of modern economics, described a pin factory in The Wealth of Nations (1776). Making a pin was divided into about eighteen distinct operations, and ten workers made upwards of 48,000 pins a day between them. Working separately, each could not have made twenty pins a day, perhaps not even one.

Worked example 2: the pin factory. Ten workers make 48,000 pins a day with division of labour. Find the output per worker and compare it with 20 pins.

Working: 48,000 ÷ 10 = 4,800 pins a day; 4,800 ÷ 20 = 240.

Answer: each worker's share is 4,800 pins a day, which is 240 times 20 pins, a number that a worker working alone could not reach.

What are the types of division of labour?

Territorial division of labour is also called localisation of industry. Black soil, for example, is ideal for growing cotton.

What are the advantages of division of labour?

Smith traced the gain in output to three causes: the greater dexterity of each worker, the saving of time lost in passing from one kind of work to another, and the invention of machines that make labour easier.

1. Increase in production: the same workers produce far more, as the pin factory shows.
2. Greater skill: repeating one task makes the worker more expert at it.
3. Saving of time: workers do not move between tasks or change tools, and one task is learnt quickly.
4. Use of machinery: simple, repeated operations can be done by machines, making large-scale production possible.
5. Inventions: a worker who concentrates on one operation is more likely to find better tools and methods.
6. Lower cost per unit: with more output from the same workers, the cost of each unit falls.

Note: Division of labour is limited by the extent of the market. Splitting work into many processes pays when a large output can be sold.

What is efficiency of labour, and why is it low in India?

Efficiency of labour means the capacity of a worker to produce more output, or better output, in a given time with given tools and materials. A simple measure is the average product of labour (APL), the output per unit of labour, where TP is total product and L the units of labour.

APL = TP ÷ L

Worked example 3: output per worker with fixed capital. With capital fixed at 4 units, total product is 40 units with 3 workers, 50 units with 4 workers and 57 units with 6 workers. Find the APL in each case.

Working: 40 ÷ 3 = 13.33; 50 ÷ 4 = 12.5; 57 ÷ 6 = 9.5.

Answer: output per worker falls from 13.33 to 12.5 and then 9.5 units as more workers share the same capital, so efficiency depends on the tools each worker has.

Why is the efficiency of Indian labour low?

1. Poor health and nutrition: a sick labourer without access to medical facilities is compelled to abstain from work, and there is loss of productivity.
2. Illiteracy: the labour skill of an educated person is more than that of an uneducated person, so low education keeps output per worker low.
3. Lack of training: few workers receive on-the-job or technical training, which enhances labour productivity.
4. Shortage of capital: capital goods raise the ability of a labourer to produce, but many small farmers and artisans still work with simple traditional tools, and the hoe, dao and digging sticks of primitive subsistence farming are still used in a few pockets of India.
5. Disguised unemployment: more people work on small farms than are needed, so each works below his or her potential.
6. Low wages and no social security: many workers do not get fair wages, and informal sector workers may get no provident fund or pension, so they cannot afford a good diet and health care.
7. Insecure casual work: the shift to casual wage work makes workers highly vulnerable and gives little reason to build skills.
8. Hot climate: hard physical work over long hours in hot and humid weather tires workers quickly.
9. Social factors: customs that restrict the choice of occupation, and reluctance to leave the village, keep workers in jobs that do not suit them.

The remedies follow from the causes. Investment in education is one of the main sources of human capital, and investments in health, on-the-job training, migration and information are the others.

What is capital, and what are its characteristics?

In economics, capital is the man-made factor of production: goods produced by people and used to produce further goods and services, such as tools, implements, machines and buildings. These are capital goods.

Capital goods are durable. They are not transformed in production and serve through many cycles of production, gradually undergoing wear and tear.

Definition: Capital is the man-made factor of production used to produce other goods and services. Its reward is interest.

What are the characteristics of capital?

1. Man-made: unlike land, capital is a human-made resource.
2. Passive factor: machines and tools produce nothing unless labour works with them.
3. Highly mobile: physical capital is completely mobile between countries except for some artificial trade restrictions, so it can even be built up through imports.
4. Depreciates: continuous use of a machine leads to depreciation, and a change of technology makes a machine obsolete.
5. Supply can be increased: an economy can add to its capital stock by producing more capital goods, unlike land.
6. Result of saving: producing more capital goods at a given time means producing fewer consumer goods, so capital is built by putting off some present consumption.
7. Raises productivity: a traditional weaver would take months to weave a sari, but with modern machinery thousands of pieces of clothing are produced in a day.

What is depreciation?

Depreciation is an annual allowance for the wear and tear of a capital good. If a machine is expected to serve for twenty years, one twentieth of its original value is treated as used up each year. It does not cover sudden destruction through accidents or natural calamities.

Depreciation = Cost of capital good ÷ Years of useful life

What are physical capital and financial capital?

Physical capital, also called real capital, consists of tangible man-made goods used in production: machines, tools and implements; buildings, office spaces and storehouses; and infrastructure such as roads, bridges, airports and jetties. It can be easily sold in the market like any other commodity.

Financial capital, also called money capital, is capital in the form of money and financial assets such as cash, bank deposits, shares and bonds. It does not produce goods directly; a firm uses it to buy machines, raw materials and the services of labour.

Buying shares, property or an insurance policy is called investment in everyday speech, but in economics investment always means capital formation, a gross or net addition to the capital stock.

What are fixed capital and working capital?

Fixed capital is used again and again over many rounds of production, such as tools, machines and buildings. Working capital is used up in a single round, such as seeds, fertilisers and raw materials, together with the money to pay for them.

What is capital formation, and how does it take place?

Capital formation means an addition to the capital stock of an economy over a period of time. The economist Ragnar Nurkse explained that society does not use the whole of its current productive activity for immediate consumption, but directs a part of it to making capital goods such as tools, machines, plant, equipment and transport facilities.

What are gross and net investment?

The part of final output made up of capital goods is gross investment. A significant part of it goes in maintaining or replacing existing capital that suffers wear and tear. Subtracting depreciation gives net investment, the new addition to the capital stock, also called new capital formation.

Net investment = Gross investment − Depreciation

Worked example 4: depreciation and net investment. A firm owns a machine bought for Rs 40 lakh, expected to last 20 years. During the year it spends Rs 10 lakh on new capital goods. Find the annual depreciation and net investment.

Working: depreciation = Rs 40 lakh ÷ 20 = Rs 2 lakh. Net investment = Rs 10 lakh − Rs 2 lakh = Rs 8 lakh.

Answer: depreciation is Rs 2 lakh, and the firm's capital stock grows by a net Rs 8 lakh.

What are the stages of capital formation?

1. Creation of savings: households, firms and the government save part of their income instead of spending all of it on consumption.
2. Mobilisation of savings: scattered savings are collected by banks and other financial institutions, which pay interest on them.
3. Investment of savings: the collected savings are lent to entrepreneurs, who use them to buy machines, build factories and create other real capital goods.

The new capital raises production and income, from which more saving becomes possible, so the process continues.

Saving = Income − Consumption

The amount saved depends on the ability to save, which rises with income, and the willingness to save. A poor household that spends almost all its income on necessities can save little.

How do banks mobilise savings?

People deposit their extra cash with banks, where it is safe and earns interest. Banks keep only a small proportion of deposits as cash; banks in India these days hold about 5 per cent of their deposits as cash. They use the major portion to extend loans, mediating between those with surplus funds, the depositors, and those who need funds, the borrowers.

A bank building marked BANK stands in the centre, with depositors on the left and borrowers on the right. Arrows show that people make deposits, and make withdrawals and get interest, between the depositors and the bank; and that people take loans, and repay loans with interest, between the bank and the borrowers.

Small savings of the poor can also be mobilised. A typical Self Help Group (SHG) has 15 to 20 members, usually from one neighbourhood, who meet and save regularly; after a year or two of regular saving, the group becomes eligible for a bank loan.

Worked example 5: from saving to loans. A worker earns Rs 30,000 in a month and spends Rs 24,000. The saving is deposited in a bank that keeps about 5 per cent of deposits as cash. Find the saving, its share of income and the amount the bank can lend.

Working: saving = Rs 30,000 − Rs 24,000 = Rs 6,000. Share = 6,000 ÷ 30,000 × 100 = 20 per cent. Cash kept = 5 per cent of Rs 6,000 = Rs 300. Available for loans = Rs 6,000 − Rs 300 = Rs 5,700.

Answer: the worker saves Rs 6,000, or 20 per cent of income, and the bank can lend about Rs 5,700 of it.

Entrepreneurs also invest their own profits. Profits are often used in the next period to buy new machinery or build new factories, so that production can be expanded.

Why does an economy need capital formation?

At a given time, with a given total output, an economy faces a trade-off: if it produces more capital goods, it produces fewer consumer goods. Yet more capital goods now means that in future labourers will have more capital equipment to work with, so the economy can produce more with the same number of labourers.

Put consumer goods on the x-axis and capital goods on the y-axis. Draw a downward sloping production possibility curve bowed outwards, and mark a point on it with a large share of capital goods. Draw a second curve of the same shape further from the origin, labelled Future, to show that more capital goods today raise the capacity to produce both goods later.

1. Raises productivity: decades were taken to build monuments like the Pyramids or the Taj Mahal, but with modern construction machinery a skyscraper can be built in a few years.
2. Speeds up growth: higher production of capital goods enables the economy to expand and raises national income.
3. Develops infrastructure: roads, bridges, airports and jetties are capital goods that support production in every sector.
4. Brings new technology: producing newer varieties of capital goods helps the greater production of consumer goods.
5. Creates employment: making capital goods and setting up new enterprises give work to more people.
6. Reduces dependence on foreign capital: a country that saves and invests enough of its own income needs to borrow less from abroad.
7. Raises the standard of living: higher output means more goods and services for people in future.

Who is an entrepreneur, and what are the entrepreneur's functions?

An entrepreneur is the person who exercises control over the major decisions of an enterprise and bears a large part of the risk associated with it. The entrepreneur hires wage labour, employs the services of capital and land, and undertakes production.

The motive is to sell the output and earn profits. In the process the entrepreneur undertakes risks and uncertainties: the price obtained may not be high enough, and profits may fall. The entrepreneur may supply the capital needed or may borrow it.

What are the functions of an entrepreneur?

1. Initiating the enterprise: the entrepreneur starts the business and decides what to produce and how much.
2. Organising the factors: the entrepreneur hires land, labour and capital and combines them in the right mix, choosing labour-intensive or capital-intensive methods according to their availability and relative cost.
3. Bearing risk and uncertainty: rent, wages and interest are paid to the other factors, and the entrepreneur keeps what is left. If the price falls, it is the profit that falls or turns into a loss.
4. Making investment decisions: the entrepreneur calculates the expected rates of return on a range of investments and rationally decides which one to make.
5. Innovation: the entrepreneur introduces new products, new methods of production and new markets. Joseph Schumpeter regarded innovation as the entrepreneur's key function.

In a simple economy where rent, wages and interest are the only payments, profit is what remains of revenue:

Profit = Revenue − (Rent + Wages + Interest)

Worked example 6: profit as the entrepreneur's reward. An entrepreneur's revenue in a year is Rs 20 lakh. She pays Rs 2 lakh as rent, Rs 10 lakh as wages and Rs 3 lakh as interest, and has no other costs. Find her profit. What happens if a fall in price cuts revenue to Rs 14 lakh?

Working: profit = Rs 20 lakh − Rs 15 lakh = Rs 5 lakh. With revenue of Rs 14 lakh: Rs 14 lakh − Rs 15 lakh = −Rs 1 lakh.

Answer: the profit is Rs 5 lakh. When revenue falls to Rs 14 lakh, the other factors are still paid Rs 15 lakh, and the entrepreneur bears a loss of Rs 1 lakh.

What role does the entrepreneur play in economic development?

The entrepreneur brings the other factors together, so the pace of development depends a great deal on the entrepreneurs an economy has.

1. Capital formation: entrepreneurs borrow savings mobilised by banks and use their own profits to buy machinery and build factories.
2. Employment: entrepreneurs hire wage labour. Self-employment also continues to be the major employment provider in India, at 58.4 per cent of the workforce in 2023-24.
3. Innovation: new products and methods raise productivity and open up new industries.
4. Efficient use of resources: choosing techniques that suit the availability and relative cost of the factors makes the best use of scarce resources.
5. Balanced regional development: enterprises set up in less developed regions spread income and jobs more widely.
6. Training of workers: firms spend on on-the-job training for their workers, which raises labour productivity.

Glossary

• Factors of production — The inputs, namely land, labour, capital and the entrepreneur, that a firm uses in the production process to produce goods and services.
• Land — All natural resources, the free gifts of nature such as soil, water, forests and minerals, that are used in production; its reward is rent.
• Productivity of land — The output obtained from a given area of land in a given period, such as tonnes of wheat per hectare in a season.
• Labour — Any human effort, physical or mental, undertaken in the production of goods and services in return for a reward, which is the wage.
• Division of labour — Splitting production into separate occupations, processes or operations, each performed by a different worker or group of workers who specialise in it.
• Efficiency of labour — The capacity of a worker to produce more, or better, output in a given time with given tools and materials.
• Capital — The man-made factor of production: goods such as tools, machines and buildings that are produced by people and used to produce other goods.
• Financial capital — Capital in the form of money and financial assets, such as bank deposits and shares, used to acquire physical capital and other inputs.
• Depreciation — The annual allowance for wear and tear of a capital good, found by dividing its cost by the number of years of its useful life.
• Capital formation — An addition to the capital stock of an economy over a period, measured by net investment, that is, gross investment minus depreciation.
• Entrepreneur — The person who takes the major decisions of an enterprise, organises the other factors and bears a large part of the risk; the reward is profit.

Common errors and misconceptions

• Misconception: In economics, land means only the soil on which crops are grown. Correct: Land covers all natural resources used in production, including water, forests, minerals and climate.
• Misconception: Buying shares or an insurance policy is investment and adds to the capital of the economy. Correct: In economics, investment means capital formation, an addition to the stock of physical capital such as machines and buildings.
• Misconception: All the capital goods produced in a year add to the capital stock. Correct: A significant part replaces worn-out capital. Only net investment, gross investment minus depreciation, is new capital formation.
• Misconception: A family in which everyone works on the farm all year is fully employed. Correct: If some members could leave without reducing output, they are in disguised unemployment.
• Misconception: Indian labour is less efficient because Indian workers do not want to work hard. Correct: Low efficiency comes from poor health, low education, little training, primitive tools, low wages and insecure casual work.
• Misconception: The entrepreneur must supply all the capital of the firm. Correct: The entrepreneur may supply the capital or borrow it; what marks the entrepreneur is control over major decisions and bearing the risk.
• Misconception: Profit is a fixed payment, like wages or rent. Correct: Profit is what remains of revenue after rent, wages and interest, so it can shrink or become a loss.

Exam-style questions with model answers

Q1. Name the four factors of production and state the reward earned by each. [2 marks]

1. Land earns rent, and labour earns wages.
2. Capital earns interest, and the entrepreneur earns profit, the part of revenue left after rent, wages and interest have been paid.

Q2. What is meant by productivity of land? Give one factor that raises it. [2 marks]

1. Productivity of land is the output obtained from a given area of land in a given period, for example tonnes of wheat per hectare in a season.
2. It is raised by modern inputs such as HYV seeds and chemical fertilisers.

Q3. Distinguish between physical capital and financial capital. [3 marks]

1. Form: physical capital consists of tangible goods such as machines, tools and buildings, while financial capital consists of money and financial assets such as deposits and shares.
2. Role: physical capital is used directly to produce goods, while financial capital is used to acquire physical capital and other inputs.
3. Investment: additions to physical capital are capital formation, while buying shares is not investment in the economist's sense.

Q4. A firm spends Rs 12 lakh on new capital goods in a year. It owns a machine bought for Rs 30 lakh with a useful life of 15 years. Calculate the annual depreciation and the net investment. [3 marks]

1. Depreciation = Cost of capital good ÷ Years of useful life = Rs 30 lakh ÷ 15 = Rs 2 lakh a year.
2. Net investment = Gross investment − Depreciation = Rs 12 lakh − Rs 2 lakh = Rs 10 lakh.
3. So the firm's capital stock grows by a net Rs 10 lakh during the year.

Q5. Explain the process of capital formation. [4 marks]

1. Creation of savings: households, firms and the government save part of their income. Saving = Income − Consumption, and it depends on the ability and willingness to save.
2. Mobilisation of savings: banks and other financial institutions collect scattered savings as deposits and pay interest on them; Self Help Groups mobilise the small savings of the poor.
3. Investment of savings: banks keep a small part of deposits as cash and lend the major portion. Entrepreneurs use these loans, and their own profits, to buy machines and build factories.
4. The new capital raises output and income, from which more saving becomes possible.

Q6. What is division of labour? Explain its three types and any two of its advantages. [5 marks]

1. Division of labour means dividing production into separate occupations, processes or operations, each performed by a different worker or group who specialise in it.
2. Simple division of labour: society is divided into occupations, such as farmer, weaver and carpenter, and each person produces a whole good or service.
3. Complex division of labour: the production of one good is split into many processes, as when pin making was divided into about eighteen operations.
4. Territorial division of labour: regions specialise in goods for which they have advantages, such as cotton on black soil.
5. Advantages: production increases, as ten workers made upwards of 48,000 pins a day; and workers gain skill by repeating one task.

Q7. Give five reasons for the low efficiency of Indian labour. [5 marks]

1. Poor health: a sick labourer without access to medical facilities is compelled to abstain from work, and productivity is lost.
2. Illiteracy: the labour skill of an educated person is more than that of an uneducated person.
3. Lack of training: few workers receive the on-the-job or technical training that enhances labour productivity.
4. Shortage of capital: many workers still use simple traditional tools, such as the hoe, dao and digging sticks in primitive subsistence farming, while capital goods raise the ability of a labourer to produce.
5. Disguised unemployment: more people work on small farms than are needed, so each works below his or her potential.

Key takeaways

• The four factors of production are land, labour, capital and the entrepreneur, earning rent, wages, interest and profit respectively.
• An economy's production structure depends on its mix of factors: labour-intensive methods use more workers, and capital-intensive methods use more machines.
• Land includes all free gifts of nature; it is limited in supply, permanent, geographically immobile, passive and heterogeneous, and has alternative uses.
• Productivity of land is output per unit area and depends on soil fertility, rainfall, irrigation, modern inputs, size of holdings, land reforms and care of land.
• Efficiency of labour is low in India because of poor health, illiteracy, little training, primitive tools, disguised unemployment, low wages and insecure work.
• Physical capital is tangible and used directly in production, while financial capital is money and financial assets used to acquire physical capital.
• Capital formation passes through the creation, mobilisation and investment of savings, and net investment equals gross investment minus depreciation.
• The entrepreneur takes the major decisions, organises the factors, bears the risk and innovates, and so drives capital formation, employment and development.

Test yourself

Why is land called a passive factor of production?

Land produces nothing by itself. It becomes productive when labour and capital are applied to it, for example when a farmer ploughs, sows and irrigates a field.

Name the three causes that Adam Smith gave for the higher output from division of labour.

The greater dexterity of each worker, the saving of time lost in passing from one kind of work to another, and the invention of machines that make labour easier.

How is the average product of labour calculated?

By dividing total product by the units of labour, APL = TP ÷ L. For example, 50 units of output from 4 workers gives an average product of 12.5 units.

Why is labour said to be perishable?

Labour cannot be stored. A working day on which a worker finds no work is lost and cannot be used later, unlike goods that can be kept for sale.

How do banks link savers and investors?

Banks accept deposits and pay interest on them, keep a small part as cash and lend the major portion to borrowers, who use the loans to buy machines and build factories.

Why does the entrepreneur, and not the worker, bear the risk of a fall in price?

Rent, wages and interest are paid to the other factors, and the entrepreneur keeps what remains of revenue. When price falls, it is this remainder, the profit, that shrinks or becomes a loss.