The main objective of an economy is to provide goods and services for the satisfaction of different types of wants of the people. This objective is achieved through production process. During production process, income is generated in the economy.
In the economy, you receive different types of incomes. You receive wages and salaries from employers. You receive interest on capital for lending money. You also receive gifts and donations from others without giving anything in return. All these incomes can be grouped into two types of incomes:
A factor income is the income accruing to a factor of production in return for the services rendered to the production unit. Production is result of the joint efforts of the four factors of production:
Labour includes all physical and mental efforts of human beings used for production of goods and services. These physical and mental efforts are inseparable. A worker requires both. Some of the jobs requires more of physical labour than mental labour and some jobs require more mental labour than physical labour. The remuneration paid to the workers is popularly termed as wages and salaries. In national income accounting, it is termed as compensation of employees.
By land in economics, we mean all that is given to us free by nature, on, below or above the surface of the earth. On the surface it includes, surface area of the soil, water, forests, etc. below the surface it includes mineral deposits, water streams, petroleum, etc., and above the surface it includes the sun, light, wind, etc.
As the land became scarce, sale and purchase of land started. Those who owned land started charging price for the use of land. Such a payment to the land owner or landlord is termed as rent.
Capital includes all the man made resources used for producing goods and services like structures on land, machines, equipments, vehicles, stock of materials etc. The payment made to the owner of capital for the use of capital is termed as interest.
It refers to the initiative taken by a person or a group of persons in starting and organizing a business. Unless somebody takes this initiative, no business can be started. The one who takes this initiative is termed as entrepreneur. The income accruing to the entrepreneur is termed as profit.
Thus, compensation of employees, rent, interest and profit are factor incomes of the factor owners.
There are certain money receipts which do not involve any sacrifice on the part of their recipients. For example, gifts, donation charities, taxes, fines, etc. No production activity is involved in getting these incomes. These income are called transfer incomes because such income merely represent transfer of money without any good or service being provided in return for the receipts. These incomes are not included in national income.