Every economy must have at least one person (we can call him Phil) and this person must occupy some amount of land. [1] “Land” as it is understood by economists is any unaltered natural resource. Ground, oceans, lakes, rivers, naturally growing fruit and vegetable, and minerals are all considered to be part of the “land.” Land is the first economic resource and it is limited to the world’s natural endowment.
In order for Phil to survive, he must eat -- he must engage in action. He must exert energy in the pursuit of attaining sustenance. He must labor. “Labor” is any exertion of energy with regards to other resources. Labor is the second economic resource and it is limited to the physical abilities of each human.
Land and labor are the two essential elements of all economies, but by themselves are only capable of maintaing a very primitive economy. It may be constructive to provide an hypothetical example of such an economy:
Phil, at the most basic level, must eat in order to survive and must therefore search for food already provided for him by nature. The search for food will last until he finds an amount of naturally provided food that is sufficient to sustain his life. Assuming that Phil is capable of searching and gathering for only ten hours a day, suppose he searches for eight hours and discovers a banana tree with a total of twenty bananas. He then spends an hour climbing the tree and an hour picking the bananas. He spent ten hours of labor in the production of food. His “real” productivity is twenty bananas per ten hours (or two bananas per hour). With these bananas he is free to consume all of them or to save some for later. Saving is the forgoing of consumption until sometime in the future. If he consumes all of the bananas he will need to repeat the process whenever he is once again in need of food. If he eats all the bananas before they spoil, he will have consumed all that he has produced. This illustrates an important and simple reality that all consumption must be a result of production. Production precedes all consumption.
Under this scenario, however, Phil will never advance. He be stuck in the primitive economy indefinitely. This is how most animals live. What is integral to Phil’s elevation out of this most primitive economy is to save.
Let’s say his required rate of consumption (for survival) is one banana per productive hour. In this case he will only need to “labor” for ten hours in order to feed himself for twenty. Given his twenty bananas, he has ten hours that could be used for productivity or for leisure, a form of consumption. If he consumes at a rate of two bananas per productive hour, he will need to spend ten hours a day producing bananas (or other food). However, he may choose to engage in savings by forgoing consumption of bananas. If he saves bananas (by eating fewer than two per productive hour) so that he may sustain his life while not searching for and producing food, he may spend the resulting saved time to develop what is known as capital. “Capital” is any good that is used in conjunction with land and/or labor to produce another good. Capital originates by mixing labor with land to create a good that is not used for consumption. [2] Capital is the third economic resource and it is limited to how much (land and labor) is saved and invested into it.
Suppose Phil realizes he can save an hour a day by investing ten hours into building a ladder. The ladder could be made with available resources, would reduce the time needed to climb the banana tree in half and also reduce the time to pick the bananas in half thereby reducing the total productive time to nine hours instead of ten. So Phil will spend a total of ten hours searching for the supplies and assembling them to make a ladder and this will lead him to save an hour a day in the production of bananas. After the ladder is built, Phil’s productivity will be twenty bananas per nine hours of labor (or 2.2 bananas per productive hour). Phil is now wealthier because he can now labor less, but still attain the same production. With his extra hour he may choose to consume it as leisure or he may reinvest it other forms of capital (like a spear for hunting) or may spend it producing other consumer goods (such as a shelter). Eventually the ladder will need to be repaired or replaced and savings will be needed to repair or replace it. If the capital is not repaired or replaced, Phil will become relatively poorer than he was with the ladder and will return to the zero point.
It must not be taken in vein that Phil can just go do things on a whim. He must determine the costs and benefits of each of his actions. Production, consumption, savings, and investment all have their own costs and benefits and it is only through Phil’s perception of what is valuable to him that he may decide to save or consume, or whether it is worth it to invest in the ladder. He will likely make many mistakes along the way, but these mistakes are part of the learning process. The lessons learned from these inductive mistake (and also the lessons learned for inductive successes) combine to form human capital. “Human capital” is the skill with which humans utilize their labor. This is a resource, but it is a qualifier for labor and is therefore included in labor. Obviously, the other resources, land and capital, just as labor does, have degrees of quality, but their is no specific name given to their respective quality.
Take away points:
- The three economic resources are Land, Labor, and Capital. The degree of skill with which labor may be utilized is called Human Capital.
- In order for something to be consumed it must first be produced
- Savings and investment are precursors to the development of Capital and Capital is a precursor to increased wealth
- Increases in wealth are the result of improvement and development of Land (using Labor and Capital to improve the land), Labor (increasing Human Capital), or Capital (saving and investing in the production of producer’s goods)
[1] While it is conceivable that in the distant future humans may be able to occupy “outer space,” that would also be characterized as “land” by economists.
[2] A good may be used as both a consumable good and a capital good and may even be used in both ways at the same time, but insofar as the good is used to produce another good, it is a capital good, and so long as it is being used for an ends in itself, it is a consumable good.