Cambridge IGCSE Business Studies

The nature of business activity

A business is an organisation that uses resources to produce goods or services that customers want. Resources are limited and wants are not, so every business, like every person and government, has to choose how to use what it has. That is the root of most of the decisions in business studies.

Factors of production

The resources a business uses are called the factors of production, and there are four.

Capital here means physical equipment, not money, although money is often needed to buy it. The person who provides enterprise is the entrepreneur: they spot the opportunity, organise the other factors and accept the risk that the business may fail. Different businesses use the factors in different proportions. A farm uses a lot of land, a software firm uses mostly labour, and a car plant uses a lot of capital.

Adding value

Added value is the difference between the selling price of a product and the cost of the materials and bought-in services used to make it.

A bakery buys flour, sugar and butter costing £1.20 per loaf and sells the loaf for £3.50. The added value is $3.50 - 1.20 = 2.30$, so £2.30 per loaf. That £2.30 has to cover the baker's wages, the oven, the rent and the owner's profit, so added value is the amount available to pay for everything the business does itself.

A business can increase added value in two ways: by cutting the cost of inputs (finding a cheaper supplier, wasting less) or by raising the selling price relative to the inputs. The second usually means making the product worth more to the customer, through a strong brand, better design, packaging, convenient service or higher quality. A plain cotton T-shirt sold under a fashion label can sell for several times the price of an identical unbranded one, though the cotton cost the same. Selling a product directly to the customer rather than through a retailer also keeps for the business the margin the retailer would have added.

Opportunity cost

Opportunity cost is the value of the next best alternative given up when a choice is made. Money, time and resources spent one way cannot be spent another.

A business with £50,000 to invest could buy a new delivery van or open a second shop. If it buys the van, the opportunity cost is the benefit it would have had from the second shop. If the van would have earned £8,000 a year and the shop £11,000, the opportunity cost of choosing the van is the £11,000 a year given up. Opportunity cost does not mean the choice was wrong, since the van may still be the better decision for other reasons such as lower risk, but it makes a business weigh what it loses as well as what it gains. Governments face the same choice: money spent on a new hospital is not available for a new school.

Economic sectors

Businesses are grouped by the type of activity they carry out.

A single chain of production often passes through all three. A cotton farmer is in the primary sector, the mill and the clothing factory are in the secondary sector, and the shop that sells the shirt is in the tertiary sector.

The importance of each sector changes as a country develops. A low-income economy typically has most of its workforce and output in the primary sector. As incomes rise and machinery replaces labour on farms, manufacturing grows and then, as people spend more on services such as travel, finance and entertainment, the tertiary sector becomes the largest. Many high-income countries have had the secondary sector shrink as manufacturing moves to countries where labour is cheaper. This is why the shape of employment in a country says something about its stage of development.

Private and public sectors

The same economy can also be divided by who owns the business.

• The private sector is made up of businesses owned by individuals or groups of private shareholders. Their main purpose is usually to make a profit for their owners. Sole traders, partnerships and companies are all private sector businesses.
• The public sector is made up of organisations owned and controlled by the government, national or local. Many aim to provide a service to the public rather than to make a profit, such as state schools, public hospitals, the police and, in some countries, the railways or the postal service. They are paid for mainly from taxes.

Some countries have a large public sector and others a small one, and governments sometimes move an organisation from one sector to the other. Selling a state-owned business to private investors is called privatisation. Its supporters argue it creates more pressure to be efficient and to compete, while its critics argue that profit-seeking may lead to the neglect of services that are not profitable, or to higher prices for essential goods.