<P> Factors of production are owned by households and they supply these factors of production to firms and in return earn wages, interest, rent and profit . Households buy goods and services with this money . </P> <P> Let one study with the help of circular flow of income how flow of goods and services between households and firms is balanced by flow of factor payments made in exchange of them . Consider the circular flow of income in a two - sector economy where there is no government, no capital market, and no foreign sector . Households own all the factors of production: land, labor, capital . These factors of production are sold to the firms to produce goods and services through factor markets . Firms make use of these resources and provide goods and services to the household through product markets . However the exchange of goods and services and factors of production takes place with the help of the financial flows that move in the reverse direction . As the households purchase goods and services from firms it is their consumption expenditure which in turn becomes income or profits for the firms . On the other hand, when firms buy factors of production from the households they pay factor payments in the form of wages, rent, interest . </P> <P> Distribution of national income is determined by factor payments (factor prices). Factor payments include rent, wages, interest and profit . The prices for factor of production depends upon demand and supply of that particular factor of production . Assume that the factors of production in the economy are fixed and hence the factor supply curve is vertical . Equilibrium of factor payments is determined by the intersection of the downward - sloping factor demand curve and the vertical supply curve . The optimal factor payments are determined through their respective markets i.e. the market clearing prices of the factors of production . There are three major factor of production Land, Labor, Capital . </P> <P> As one knows that the firm will hire only the optimal amount of labor that will maximize profit, this optimal quantity of labor depends upon the marginal product of labor (MPL). The marginal product of labor is defined as the extra unit of output that the firm produces from hiring one extra unit of labor . </P>

4 factors of production and their corresponding payments