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Overview of Economic Resources

Reference page:  Economic Resources and Their Respective Returns

To produce a product (a good or service),  a business needs resources, such as labor (i.e., workers), land (e.g., a building), equipment, cash (capital) and other resources.  Restated, to operate a business, the manager needs resources, and one of the manager's responsibilities is to decide which resources to use and how to use them. 

This page reviews how economic theory describes resources needed to produce a product.  The page also introduces an alternative description that is followed throughout this course.

Economic Theory Description

Economic resources used in the production of goods and services can be categorized as

• Land (all natural resources),
• Labor (all physical and mental talents of individuals),
• Capital (all manufactured aids used in producing goods and services, and cash), and
• Entrepreneurial ability (the initiator, innovator, strategic decision maker, risk taker; restated, the person with the willingness and ability to initiate a business, innovate new ideas, and bear the risk of owning a business).

The respective returns to these resources is often described as

• rent for land;
• wages for labor;
• interest for capital; and
• profit for the entrepreneur.

That is, the owner of land is entitled to receive rent, the worker is entitled to receive a wage, the owner of capital is entitled to an interest payment, and the entrepreneur retains any profit.

Based on Economic Resources (and their return), McConnell and Brue. Economics 16th ed. Boston: McGraw-Hill Irwin. 2005.

Alternative Description

Would it be helpful to categorize the economic resources and their returns as: land (rent), labor (wage), capital (interest), information (royalty), and assuming the risk of a net operating loss (profit)?

Restated, is there an alternative description for economic resources?  How about:

• land (natural resources),
• labor (physical and mental talents of individuals, including management skills),
• capital (cash and the manufactured products (e.g., tools and equipment) used to produce other products),
• information and innovation (assembling information about market opportunities and creating production technologies), and
• accepting or bearing risk of business ownership (willingness and ability to bear the risk of owning a business that may incur a net operating loss)

The respective returns to these resources would be

• rent for land;
• wages for labor (including management);
• interest for capital;
• royalty for information; and
• profit for bearing risk of business ownership.

The primary differences between the two descriptions are

• being a manager does not entitle an individual to the profit; a person must accept the risk that the business may incur a net operating loss to be entitled to the profit;
• market information and production technology are economic resources that can be bought, sold and controlled; and
• the persons who have information is entitled to be compensated for their information.

Additional thoughts about the resource categories:

• Management is a type of labor and managers are entitled only to a wage (not profit).
• A business owner can own each of these resources and use them in their own business, or the business owner can acquire each of these resources from another person and then use the resources in the business, such as hiring an employee, renting land or borrowing capital.
  • Capital is a combination of debt and equity capital.
  • Land is a combination of owned and leased land.
• Information encompasses production technology and market information.
  • Market information includes information about both input and product markets.
  • Information can be 1) public, 2) private but available for purchase, or 3) private and unavailable; the implications of these three categories of information are discussed throughout these materials.
• Some resources do not fit neatly into just one category, for example, is it labor when a person knows how to produce a product (that is, a skill of the owner or an employee that is compensated with a wage) or is that knowledge a type of information?
• Risk is a combination of 1) an ability or capacity to bear risk and 2) a willingness to bear risk; both are needed to assume or bear risk; this combination is discussed throughout these materials.
  • A business can pay someone to assume risk, e.g., insurance; but risk also is altered or managed when the business owner pays extra for an input to assure the input is always available for the business operation
  • A challenge for a business decision maker is to recognize "that if business owners pay for all risks to be assumed, no profit will remain for them".

Can you think of examples where this alternative description of economic resources may impact our analysis of a situation?

• What might be the implications of government subsidized crop insurance? Who is bearing the risk of a failed crop and what might they want in exchange for assuming that risk?
• Consider crops and livestock that have been altered through biotechnology; who has invested what and what is that entity entitled to receive (based on economic theory)?

To what extent can each of these resources be "purchased" if the business owner does not already possess them? To what extent does the business owner have to bring these resources to the enterprise, rather than rely on someone else to provide them?  What is the impact of the business owner "purchasing" the resources, rather than "bringing them" to the business?

This description of economic resources will be revisited throughout these materials.

Reminder:  a person who owns an economic resource is entitled to be compensated by the business that uses the economic resource.  Likewise, a person who owns an economic resource and uses it in his or her own business also is entitled to be compensated for the use of that resource, that is, the business should return enough to the resource/business owner to compensate for using that resource in their own business.  This expectation is discussed in more detail in a later section as part of accounting profit and opportunity cost.

The next topic suggests that management is decision making; such as, deciding how a business uses these economic resources to produce a product.

Last Updated August 23, 2010

Email: David.Saxowsky@ndsu.edu

This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.

E-Mail:sswandal@ndsuext.nodak.edu
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