Learning about earning

A blog by Aman Ganguli

What is it besides air, water and food that you need to stay alive and also interests an Economist?


However, the important question that follows is

How does one earn money?

The instant answer that would come to your mind is job or business. When you run a business or do a job you earn income which can be in a form other than money as well. For the purpose of this article, we will assume that income is earned only in the form of money.

In Economics, the ways of earning money income

are encapsulated in the four factors of production. Factors of production mean the resources that are used for the production of output. There are four factors of production and this four-factor of production are a source of income for individuals :

  • Land
  • Labor
  • Capital
  • Entrepreneurship

We understand the concept mentioned above with the help of an example.

Suppose there is an individual A who wants to set up a factory to produce Pens. In order to set up the factory A requires land, there is another individual B who has land and is willing to lease it to A. An agreement is reached between A and B whereby B allows A to use the land in return of monthly payment. Hence, land which is required to set up a factory to produce pen is a factor of production and also a source of income for B.

Once A gets the land to set up his factory he/she would require people to work in that factory or what is called labor in economics. The labor brings itself the skill set required for production in return he/she gets a salary. Hence, labor the second factor of production also becomes a source of income.

The labor in the factory would need machines and equipment to produce the desired output i.e. pen. Suppose there is person C who has all the required machinery for production of pen and he/she gives it to A in return of hourly rent. Here the capital of C which is machines are required for pen production and is also a source of income.

Now, A  which has taken all this effort and pain to get land, hire labor and rent equipment is the entrepreneur. Without his entrepreneurship production of the pen would not be feasible. Hence it is the fourth factor of production. In return for his efforts, he is entitled to the profit that he makes by selling pens and paying each factor of production its share i.e. rent to B for land, salary to labor and capital rent to C for machines.

Now, we shift our focus on how does the government earns its income?

The most common answer would be Taxes. A tax is a compulsory payment made by the citizens of the country to the Government. The government uses the money raised from taxes to carry out various services which include roadways, public sanitation and defense maintenance to name a few. We all hate to pay taxes thinking of it as a unilateral payment made to Government, doled out from our hard earned income but we fail to realize that it is a cost of a lot of services that we receive as a whole. Taxes are deducted as a certain fraction of our Income but

 Do higher tax rates mean higher revenue for the government?

No, Economist Arthur Laffer through the Laffer cure illustrates that the Government Revenue decreases as the tax rates increase, the main reason being the loss of incentive to work more and earn a higher money income because most of it is deducted as taxes.  To understand this let us consider a hypothetical situation if the current tax rate is 15% i.e. for Rs 100 that you earn the government takes away Rs 15 . To increase its tax revenue the government increases tax rate year after year to  20 %, 25% and after some years to say 50%. When the tax rate becomes very high people in the economy become discouraged and reduce the efforts they put in their work.

Laffer Curve

The other sources of income for the government are seigniorage, ( to be discussed in detail in another blog), profit from enterprises it owns like Indian Railways, fines, fees and many more. The government like individuals can also take a loan from various sources like the normal public, other countries or an international organization like the World Bank and the International Monetary Fund. The government also receives fund during a disaster. Recently, many of us contributed money for Kerala Flood Relief and Bihar Flood Relief. Although no government would want to depend on this as a source of income because of the huge loss to life and property in such a disaster.

1 thought on “Learning about earning”

  1. Clearly the ideas imparted are quite substantial for general information of Economics..
    Being an Economics hons student, I found it quite informative, engaging and instructive.

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