0264 · 1.1.1The nature of business activity

Business activity and scarcity

0:00A bakery turns flour, eggs and other ingredients into a cake that customers are willing to buy. The finished product can sell for considerably more than its ingredients cost. That difference helps the bakery pay for the work involved. By the end of this video, you will understand the resources businesses use, the choices they face and how they create added value. Business activity combines the factors of production to make goods and services that satisfy needs and wants.

0:25Factors of production are the resources used to produce goods and services. Goods are physical products, while services are activities carried out for customers. Examples include cakes and bicycles as goods, and haircuts and repairs as services. Needs are things essential for survival, such as food, water, shelter and clothing. People also have wants, which are desires beyond needs and are unlimited. Someone needs food, but may want a specially decorated birthday cake.

0:52Businesses use resources to provide products that meet these different requirements. Scarcity means that resources are limited while wants are unlimited. There is only so much land, equipment, human effort and time available. A bakery with one oven must choose how to use its available baking time. Scarcity therefore forces choices about which products to make and which opportunities to pursue.

Factors of production

1:14Land means the natural resources used in production. This includes soil, minerals, forests, fish and oil. At Meadow Farm, the soil used to grow wheat is land. Land covers everything supplied by nature, so this factor is identified by its natural origin. The physical and mental human effort used in production is called labour. A baker kneading dough provides physical effort, while planning recipes is mental work. At Lena’s Salon, employees use their skill and concentration to cut customers’ hair.

1:44Both practical work and thinking contribute to the service customers receive. Capital means the man-made resources used in production. A bakery’s ovens, mixing equipment, delivery vehicle and building are examples. These resources help employees turn ingredients into finished cakes. Money is used to buy capital, and the factor itself is the equipment, machinery and buildings that help production. Finally, enterprise is the skill and risk-taking of the entrepreneur who combines the other factors of production.

2:12An entrepreneur is a person who organises, operates and takes the risk for a new business venture. The bakery’s owner chooses recipes, arranges equipment and employs bakers. The owner commits resources before knowing whether enough customers will buy the cakes. These resources work together because each contributes something different to production. The oven provides baking capacity, employees prepare the mixture, and ingredients come from natural resources. Enterprise brings these contributions together into an organised business.

2:41The conventional rewards are rent for land, wages for labour, interest for capital and profit for enterprise.

Opportunity cost

2:47Limited resources mean that choosing one option can require giving up another. Opportunity cost is the next best alternative given up when a choice is made. This helps us recognise the sacrifice behind a decision. We compare the chosen option with the most valuable alternative that could realistically have been selected. Willow Cafe has enough money for either a new oven or an advertising campaign. Its owner chooses the oven because the existing equipment cannot bake enough food.

3:13The advertising campaign is the next best alternative given up, so it is the opportunity cost. The decision sacrifices a chance to attract customers in exchange for greater baking capacity. Opportunity cost also applies to your time, because an hour can have several possible uses. Suppose you spend an hour revising business, and your next best choice was football practice. That practice is the opportunity cost of revising. Identifying the next best alternative makes the trade-off clear, even when the choice involves no payment.

Added value and exam technique

3:44Added value is the difference between the selling price of a product and the cost of the bought-in materials and components used to make it. A bakery buys ingredients, then uses skill and equipment to create something customers want. Decoration, taste and convenience can increase customers’ willingness to pay. The business captures that difference when it sells the finished cake. Sunrise Bakery sells a cake for twenty dollars. The ingredients and box bought from suppliers cost eight dollars per cake.

4:11To calculate added value, subtract the bought-in materials cost from the selling price. Twenty dollars minus eight dollars gives twelve dollars of added value per cake. The subtraction separates the suppliers’ contribution from the value created through the bakery’s activity. Of the twenty dollars received, eight dollars covers the bought-in ingredients and box. The remaining twelve dollars must help cover wages, rent and other costs. Profit is total revenue minus total costs.

4:37It is what remains after these costs are paid as well. Added value and profit are therefore two different measures. To increase added value per product, a business must widen the gap between selling price and bought-in materials cost. One route is to obtain a higher price through features customers value. Alternatively, the business can reduce the cost of those materials. Both approaches require care because customers still need a product they consider worth buying.

5:03Exclusive design can make a cake more desirable because it matches a customer’s particular celebration. Better packaging can protect it during transport and improve its presentation. Improved quality, such as a richer flavour, can also support a higher price. Each improvement increases added value only when the price increase exceeds any extra bought-in materials cost. A brand is a name, symbol or design that identifies a product as made by a particular business.

5:31A bakery whose brand is known for dependable celebration cakes gains customers’ confidence, so they accept a higher price. Convenience, such as delivery at a suitable time, gives another reason to pay more. Helpful customer service, such as advice on choosing a design, also makes customers willing to pay a little extra. A higher price succeeds when customers believe the extra benefit justifies the additional payment. Some may choose another seller if the price rises beyond what they will pay.

5:58The business therefore needs to consider customers’ preferences before changing its offer. Delivery and personal service also create costs that must be covered before profit remains. A business can reduce bought-in materials costs by finding a cheaper supplier that provides suitable quality. For Sunrise Bakery, this might mean obtaining the same flour at a lower price. Careful measuring and storage can reduce ingredient waste per cake sold. With the selling price unchanged, either saving increases the gap that represents added value.

6:27Cheaper ingredients can create problems if they reduce flavour or make cakes less reliable. Disappointed customers may stop buying, which harms the bakery’s sales. A supplier offering a lower price therefore needs to meet the required standard. Reducing waste lowers costs without changing the ingredients, so quality can stay the same. In Paper One Short Answer and Data Response and Paper Two Case Study, use the business information to support your answer.

6:53An exam-style task might say: explain how personalised designs could increase Sunrise Bakery’s added value. Explain means set out purposes or reasons, say why and how, supported with relevant evidence. Link the design to customers’ willingness to pay, then compare the price rise with the materials cost. Sunrise Bakery’s customers request personalised designs, so a cake matching their celebration gives them a reason to pay more. The bakery can increase its selling price if customers accept that extra charge.

7:22If the increase exceeds the additional bought-in decoration cost, the gap between price and materials cost becomes larger. Added value per cake therefore increases. Accurate answers keep added value and profit separate. Added value uses only the selling price and the bought-in materials cost. Profit also takes away wages, rent and every other cost. An opportunity cost answer names the single next best alternative that was given up. To classify a resource, decide whether it is natural, human effort, man-made or the entrepreneur’s organising skill and risk-taking.

7:55Land means the natural resources used in production. The physical and mental human effort used in production is called labour. Capital means the man-made resources used in production. Finally, enterprise is the skill and risk-taking of the entrepreneur who combines the other factors of production. Opportunity cost is the next best alternative given up when a choice is made. Scarcity makes choices necessary, while production brings resources together to meet customers’ requirements.

8:22Added value is the difference between the selling price of a product and the cost of the bought-in materials and components used to make it. A business increases added value by raising its price or cutting its bought-in materials cost, as long as quality and customer demand are protected.