1

BUSINESS ACTIVITY

This chapter will explain:

• the concepts of needs, wants, scarcity and opportunity cost
• the importance of specialisation
• the purpose of business activity
• the concept of adding value and how added value can be increased.

1.1 The economic problem: needs, wants, scarcity and opportunity cost
What do you notice about your two lists? Probably the really important items are on the
needs list – water, clothing for warmth and protection, food and some form of housing or
shelter. And on your wants list? That will be up to you and your interests and tastes, but
you could probably have written a very long list indeed. Do you already own all of the
items on your wants list? If you do, then you must be very lucky and very rich! Most
people in the world cannot afford to buy everything they want because our wants are
unlimited. In many countries, some people cannot afford to buy the things they need
and they are likely to be very poor. Why are there so many wants and needs that we
cannot satisfy? Why are millions of people living in poverty in many countries around
the world? Most people will answer these questions by saying, ‘Because there is not
enough money.’ Is the real economic problem caused by a shortage of money? An
example may help to show you why more money is not the answer to the problem of
many people’s wants and needs not being satisfied.
Case study
The government of a small country is worried about large numbers of people who cannot
afford the basic needs of life. Even those citizens with more money are always
complaining that the country is not producing enough of the luxuries that they want to
buy. The government decides to try to ‘solve’ these problems by printing more bank
notes, doubling everyone’s incomes. Has the government solved the economic problem of
the country? Are there now more goods for the people to buy? More houses? More
schools? More cars? Improved standard of living of the population? The answer to all of
these questions is ‘No’. Printing more money does not produce more goods and services.
It will just lead to prices rising so more goods cannot be afforded – you just pay more for
the same amount of goods.
The economic problem – the real cause
The real cause of the shortage or scarcity of goods and services is that there are not enough
factors of production to make all of the goods and services that the population needs and
wants. There are four factors of production:
• Land – this term is used to cover all of the natural resources provided by nature and includes
fields and forests, oil, gas, metals and other mineral resources.
• Labour – this is the number of people available to make products.
• Capital – this is the finance, machinery and equipment needed for the manufacture of goods.
• Enterprise – this is the skill and risk-taking ability of the person who brings the other
resources or factors of production together to produce a good or service, for example, the
owner of a business. These people are called entrepreneurs.
In any one country, and in the world as a whole, these factors of production are limited in
supply. As there is never enough land, labour, capital or enterprise to produce all of the needs
and unlimited wants of a whole population, there is an economic problem of scarcity.
Limited resources: the need to choose
We make choices every day. We have to, as we have limited resources but so many wants.
We therefore have to decide which wants we will satisfy and which we will not. All choices
involve giving something up – this leads to opportunity cost. Should I take a bus to school or
use the money for a new pen to write clear Business Studies notes? Do I buy a new pair of
trainers or spend the money on a new smartphone? We do not have the resources to satisfy
all our wants, so the next best alternative that we give up becomes our opportunity cost.
This problem of ‘what to give up’ exists not only for consumers like us but for governments
and businesses too. In making choices we need to consider carefully the opportunity cost
to make sure it is not worth more to us than the item we are buying.
REVISION SUMMARY
The economic problem
The importance of specialisation: the best use of limited resources
In all societies the factors of production are in limited supply. It is therefore important to use
these resources in the most efficient ways possible. The ways in which these resources are
used have changed greatly in the last 250 years. Very few products are now made just by the
efforts and skills of one worker. Nearly all workers specialise in particular skills and many
businesses specialise in one type of product. Specialisation is now very common because:
• specialised machinery and technologies are now widely available
• increasing competition means that businesses have to keep costs low
• most people recognise that higher living standards can result from being specialised.
Case study
This is how Joe Sharma, a carpenter, went about making a table 250 years ago:

What do you notice about these methods of production?

• Joe did everything himself – including the cutting of the timber and the sale and delivery of
the finished table.
• Production was very low – only one table per week.
• Compare this with typical modern production methods. Two hundred and fifty years
later, Jack Sharma owns the family business. This is how production is organised:
Specialisation and the division of labour
Jack Sharma is using the principles of specialisation and division of labour. He is dividing up
the making of tables into different jobs and making each worker a specialist at just one task.
Division of labour has advantages and disadvantages:
The purpose of business activity We have identified the following issues:
• People have unlimited wants.
• The four factors of production – the resources needed to make goods – are in limited supply.
• Scarcity results from limited resources and unlimited wants.
• Choice is necessary when resources are scarce. This leads to opportunity cost.
• Specialisation improves the efficient use of resources. So far, we have hardly mentioned
businesses and yet this is the purpose of this book! Where does business activity fit into the
ideas we have already looked at? The purpose of all businesses is to combine the factors of
production to make products which will satisfy people’s wants. These products can either be
goods – physical items such as cars and shoes which we can touch and see – or they can be
services, such as insurance, tourism or banking. Businesses can be small – just one person,
for example – or large. Some businesses employ thousands of people with operations in
many different countries. Businesses can be privately owned or owned by the
state/government. They can be owned by one person or by thousands of shareholders.
Whatever their size and whoever owns them, all businesses have one thing in common – they
combine factors of production to make products which satisfy people’s wants.
What would life be like without business activity? In simple, undeveloped economies,
businesses do not exist. Everyone attempts to do everything for themselves – they are self-
sufficient. With their own plot of land and by their own efforts, such as hunting, they attempt to
survive and produce enough for their own needs. This is a very basic existence and living
standards are low

By a slow process of specialisation, people began to concentrate on what they were best
at. They then traded those goods for others made by people who had different skills. In
this way, businesses began to be formed, and trade and exchange of goods expanded.
In today’s world, most people specialise by working in one job for a weekly wage.
With this money, they are able to purchase a wide range of goods and services produced by
many different businesses – specialising in different products. Business activity therefore:
• combines scarce factors of production to produce goods and services
• produces goods and services which are needed to satisfy the needs and wants of the
population
• employs people as workers and pays them wages to allow them to consume products
made by other people.

Added value
This is a very important idea. All businesses attempt to add value. If value is not added to
the materials and components that a business buys in, then:
• other costs cannot be paid for
• no profit will be made.
Example:
• The selling price of a newly built house is $100 000.
• The value of the bought-in bricks, cement, wood and other materials was $15 000.
• The added value of the building firm was $85 000. This is not all profit – out of this the
builder must pay wages and other costs too.
Why is added value important?
Added value is important because sales revenue is greater than the cost of materials bought
in by the business. This means the business:
• can pay other costs such as labour costs, management expenses and costs including
advertising and power
• may be able to make a profit if these other costs come to a total that is less than the added
value.

How could a business increase added value?

There are two main ways in which a business can try to increase its added value:
a. Increase selling price but keep the cost of materials the same. This might be possible if the
business tries to create a higher quality image for its product or service. If consumers are
convinced by this then they might be prepared to pay higher prices and buy the same quantity
as before the price rise. A jewellery shop could employ very experienced and
knowledgeable sales staff, decorate the shop to look luxurious and use high-quality
packaging.
Note though: other costs might increase when trying to create this quality image.
b. Reduce the cost of materials but keep the price the same. A building firm could use cheaper
wood, bricks and other materials when constructing a home or shop. If the price charged to
customers stays the same then a higher added value will be made. Note though: lower priced
materials might reduce the quality of the product. Will customers be prepared to pay the same
price for a product that they believe is of lower quality?
REVISION SUMMARY

Case study: Rakesh’s bakery

Rakesh owns a small bakery selling bread, cakes and biscuits. His business is just
making enough money to survive. His wife, Neeta, had the idea of serving customers tea
and coffee at two small tables that could be fitted into the bakery shop. ‘Customers will
pay more for each cake and biscuit if we sell them with tea or coffee – just like a little
café.’ Rakesh bought some second-hand café equipment and furniture and tried what
Neeta had suggested. She was right! Some of his customers not only bought teas and
coffees but they paid higher prices for the cakes and biscuits they bought as they were
served them on a plate! Rakesh had increased the value added to the flour, sugar and butter
he used to make these cakes and biscuits.

International business in focus Division of labour at McDonald’s

The cooking of food in all McDonald’s restaurants is broken down into small, repetitive tasks.
These include serving customers, pouring drinks, cooking French fries and cooking burgers.
These separate tasks allow workers to become very efficient and skilled in them. All workers
are given much training in the tasks that they will become skilled at.
The speed and efficiency of McDonald’s workers means that customers are served very quickly
with freshly cooked food. Costs are kept very low and this helps to keep prices low. McDonald’s
and other fast-food restaurants often make great efforts to reduce the high labour turnover in
this industry; this means they are trying to reduce the high number of workers that leave the
industry each year.
Discussion points
• Why do you think a large business such as McDonald’s uses specialisation?
• Think about as many advantages as you can to McDonald’s of using specialisation.
• If you owned a fast-food restaurant, consider two ways in which you could increase the
value added to the food bought in by the restaurant.

Exam-style questions: Short answer and data response

1. Gowri plans to start up her own business using her savings. She wants to produce fashion
clothes for women. She is a very good clothes designer but she does not like stitching
clothes together. Two friends have offered to help Gowri. Abha is an experienced material or
fabric cutter – she can cut lengths of material or fabric for clothes with very little wastage.
Aditi is quick at sewing fabric together.
a Define ‘business’. [2]
b Identify two factors of production that Gowri will need for her new business. [2]
c Outline two possible opportunity costs that Gowri may have from her decision to start her
own business. [4]
d Explain one advantage and one disadvantage to Gowri’s business of using division of
labour in making clothes. [6]
e Do you think that Gowri’s business will be able to sell all of the clothes that it makes? Justify
your answer. [6]
2. Mohammed owns a bakery. He makes bread and cakes. He employs three workers who
help him mix the dough for the bread and cakes, put the dough into tins, bake the bread and
cakes, and serve customers. Mohammed has calculated that the ‘added value’ of his business
is low. His customers complain when he tries to increase his prices. ‘We can buy the same
bread and cakes at lower prices,’ they tell him.
a Define ‘added value’. [2]
b Identify the opportunity cost to Mohammed of buying a new oven. [2]
c Outline two benefits to Mohammed’s business of all of his workers being able
to do all of the jobs in the bakery. [4]
d Explain two ways in which Mohammed could increase the value added of his bakery
business. [6]
e A friend told Mohammed, ‘Your business would be more successful if you only served in the
shop and let your workers make the bread and cakes.’ Do you agree? Justify your answer.
[6]
Definitions to learn
A need is a good or service essential for living.
A want is a good or service which people would like to have, but which is not essential
for living. People’s wants are unlimited.
The economic problem – there exist unlimited wants but limited resources to produce
the goods and services to satisfy those wants. This creates scarcity.
Factors of production are those resources needed to produce goods or services.
There are four factors of production and they are in limited supply.
Scarcity is the lack of sufficient products to fulfil the total wants of the population.
Opportunity cost is the next best alternative given up by choosing another item.
Specialisation occurs when people and businesses concentrate on what they are best
at.
Division of labour is when the production process is split up into different tasks and
each worker performs one of these tasks. It is a form of specialisation.
Businesses combine factors of production to make products (goods and services) which
satisfy people’s wants.
Added value is the difference between the selling price of a product and the cost of bought-in
materials and components.