Business activity | IGCSE Class 10 Business Studies Notes

This note covers the concepts of needs and wants, scarcity and opportunity cost, the importance of specialisation, the purpose of business activity, and the concept of added value and how a business can increase it.

What are needs and wants?

Every person has to make choices about how to use the limited resources available to them. Economists divide what people want into two categories: needs and wants.

Definition: needs. Needs are the goods and services that are essential for survival, such as food, water, shelter and clothing.

Definition: wants. Wants are the goods and services that people would like to have but which are not essential for survival, such as a smartphone, a holiday or a branded pair of trainers.

A business exists to satisfy both needs and wants. A bakery satisfies a basic need for food, while a cinema or a games console manufacturer satisfies a want.

Because resources such as time, money, land and raw materials are limited, no individual, household, business or government can satisfy every want. This is the root of the economic problem that all business activity tries to address.

What is scarcity and opportunity cost?

Definition: scarcity. Scarcity is the imbalance between the relatively unlimited wants of people and the limited resources (land, labour, capital and enterprise) available to satisfy them.

Because resources are scarce, every choice to use a resource in one way means it cannot be used in another way at the same time. This gives rise to opportunity cost.

Definition: opportunity cost. Opportunity cost is the next best alternative given up when a choice is made between two or more options.

Opportunity cost applies at every level of economic activity. A government choosing to spend money on a new hospital gives up the opportunity to spend that money on a new school.

A business that uses its factory to make bicycles gives up the opportunity to use that same factory space, labour and capital to make something else.

A consumer who spends $20 on a cinema ticket gives up the chance to spend that $20 on a meal out.

Understanding opportunity cost helps a business owner, a consumer or a government weigh up the true cost of any decision, which is not just the money spent but the best alternative use of the resource that is sacrificed.

Why is specialisation important?

Definition: specialisation. Specialisation is the concentration by a worker, a business or a country on producing a narrow range of goods, services or tasks, rather than trying to produce everything itself.

Specialisation happens at several levels. A worker may specialise in a single task on a production line, a form known as division of labour: breaking a job down into separate tasks so that different workers each concentrate on one small part of the process.

A business may specialise in one product or one stage of production, such as a company that only makes car tyres rather than whole vehicles.

A country may specialise in producing the goods or services it is best placed to produce, because of its climate, natural resources or skills, and trade with other countries for the goods it does not produce itself, which is the basis of comparative advantage.

Advantages of specialisation

1. Workers who repeat the same task become faster and more skilled at it, which raises output per worker.
2. Less time is wasted moving between different tasks or tools, so production is more continuous.
3. A business can invest in specialist machinery suited to one task, rather than general-purpose equipment, which lowers the average cost of each unit produced.
4. Specialisation between countries allows each country to produce what it does best and trade for the rest, increasing total world output.
5. Training costs are lower because a worker only needs to be trained for one narrow task rather than for a whole process.

Limitations of specialisation

1. Repeating the same task all day can become boring for workers, which may lower motivation and quality.
2. If one specialised worker or supplier is absent or fails, the whole production process can be held up, because each stage depends on the one before it.
3. Workers who only ever learn one narrow task find it harder to move to a different job if their task is automated or no longer needed.
4. A country that specialises heavily in one product or industry becomes vulnerable if world demand for that product falls.

What is the purpose of business activity?

Business activity brings together resources, often described as the factors of production (land, labour, capital and enterprise), to produce goods and services that satisfy the needs and wants identified above.

A business combines these resources, usually with the aim of earning a profit, which is the excess of revenue earned over the costs incurred.

Profit is an important objective for most businesses because it is a source of income for the owners, a source of finance for growing the business, and a sign that the business is producing something people are willing to pay for.

However, a single-minded focus on profit is not enough on its own. A business also has to consider other objectives if it wants to survive and prosper, including building a strong market standing against its competitors by offering good products at reasonable prices, encouraging innovation in its products and in how it produces and sells them, raising productivity (the value of what it produces compared with the value of the resources it uses), acquiring the physical and financial resources it needs, and meeting its wider social responsibility to the community it operates in.

In short, the purpose of business activity is to use scarce resources to produce goods and services, satisfying needs and wants, while balancing the aim of earning profit against these other objectives.

What is added value and how can it be increased?

Definition: added value. Added value is the difference between the selling price of a finished product and the cost of the bought-in materials and components used to make it.

Added value = Selling price − cost of bought-in materials

Adding value is one of the main reasons businesses can succeed. A business that simply passes on raw materials unchanged, at the same price it paid for them, adds no value and earns no profit margin.

By transforming raw materials and components into something customers are willing to pay more for, a business creates added value, which can then be used to cover other costs, such as wages, rent and marketing, and to generate profit.

A business can increase the added value of its product in several ways, without necessarily increasing the cost of the materials used.

Worked example 1. A furniture maker buys wood and fittings costing $60 for one chair. The chair is sold for $150.

Answer: Added value = Selling price − cost of bought-in materials = $150 − $60 = $90.

This $90 is the value the furniture maker has added through labour, design and skill, and it is from this $90 that the business must pay its other costs, such as wages and rent, before any profit is left over.

Worked example 2. Two furniture makers buy identical wood costing $60. Maker A sells a plain chair for $100. Maker B carves the same chair with a decorative pattern and sells it, branded, for $180.

Answer: Maker A's added value is $100 − $60 = $40. Maker B's added value is $180 − $60 = $120. Maker B has increased added value through skilled labour (carving) and branding, even though the cost of materials was identical for both makers.

Going beyond the syllabus

The idea of comparative advantage, where a country specialises in producing the goods it is relatively best suited to producing and trades for the rest, extends the logic of specialisation from individual workers to entire economies, and explains why most countries trade with one another rather than trying to produce everything themselves.

Glossary

• Need: a good or service essential for survival, such as food, water or shelter.
• Want: a good or service people would like but which is not essential for survival.
• Scarcity: the imbalance between unlimited wants and the limited resources available to satisfy them.
• Opportunity cost: the next best alternative given up when a choice is made.
• Specialisation: concentrating on producing a narrow range of goods, services or tasks.
• Division of labour: breaking a production process into separate tasks, each done by a different worker.
• Added value: the difference between the selling price of a product and the cost of its bought-in materials.
• Factors of production: the resources used to produce goods and services: land, labour, capital and enterprise.
• Bought-in materials: the raw materials and components a business buys from suppliers to make its product.
• Comparative advantage: the ability of a country to produce a good relatively more efficiently than other countries, so it is worth specialising in.
• Market standing: a business's reputation and position relative to its competitors in the market.
• Social responsibility: the obligation of a business to act in a way that benefits wider society, not only its owners.
• Profit: the excess of revenue earned by a business over the costs it has incurred.
• Economic activity: an activity undertaken to earn a living or an income, as opposed to one performed out of love or duty.

Common errors and misconceptions

• Misconception: a want is simply a bigger or more expensive need. Correct: a want is not essential for survival at all, while a need is essential; a basic meal is a need, a meal at an expensive restaurant is a want.
• Misconception: opportunity cost means the money spent on a choice. Correct: opportunity cost is the next best alternative given up, not the money itself.
• Misconception: scarcity only applies to poor countries or poor people. Correct: scarcity applies to every economy and every individual, because wants always exceed the resources available to satisfy them.
• Misconception: specialisation has no disadvantages. Correct: specialisation can cause boredom, over-dependence on one supplier or worker, and difficulty retraining if the specialised task disappears.
• Misconception: added value is the same as profit. Correct: added value is selling price minus bought-in materials, before other costs such as wages and rent are deducted; profit is calculated after all costs, not just materials.
• Misconception: the only purpose of business is to earn profit. Correct: profit is an important objective but businesses also pursue market standing, innovation, productivity and social responsibility.
• Misconception: adding value always means raising the price charged. Correct: added value can be increased by lowering the cost of bought-in materials while keeping the selling price the same, as well as by raising the price.

Exam-style questions with model answers

Q1. State two examples of a need. [2 marks]

1. Any two of: food, water, shelter, clothing. These are essential for survival, unlike wants, which are desirable but not essential.

Q2. Define opportunity cost. [2 marks]

1. Opportunity cost is the next best alternative given up when a choice is made between two or more options, for example when a government chooses to spend money on one project rather than another.

Q3. Explain two reasons why scarcity means that people face opportunity cost. [4 marks]

1. Resources such as money, time, land and raw materials are limited, so choosing to use a resource for one purpose means it cannot be used for another purpose at the same time, which creates an opportunity cost.
2. Because wants are relatively unlimited while resources are limited, every individual, business or government must choose which wants to satisfy first, and the alternatives not chosen become the opportunity cost of that choice.

Q4. Explain two advantages of specialisation for a worker on a production line. [4 marks]

1. Repeating the same narrow task makes the worker faster and more skilled at it, which raises their output per hour compared with doing many different tasks.
2. Training costs and time are reduced because the worker only needs to learn one task well, rather than being trained across the whole production process.

Q5. A furniture maker buys wood and fittings for a chair costing $60 and sells the finished chair for $150. Calculate the added value of the chair, and explain one way the business could increase this added value. [6 marks]

1. Added value = selling price − cost of bought-in materials = $150 − $60 = $90.
2. This $90 represents the value the business has created through labour, design and skill, and it is from this amount that other costs, such as wages and rent, must be covered.
3. One way to increase added value is to build a recognised brand for the chair, which allows the business to charge a higher selling price without increasing the cost of the wood and fittings used.
4. Alternatively, the business could add decorative carving or finishing using skilled labour, making the chair appear more exclusive and justifying a higher price, again without raising the cost of the bought-in materials.

Q6. State three ways a business could increase the added value of its product. [3 marks]

1. Building a brand that customers are willing to pay more for.
2. Improving the quality or design of the product.
3. Offering faster delivery, a more convenient location, or better customer service.

Q7. Discuss whether specialisation is always beneficial to a business. [6 marks]

1. Specialisation can raise output per worker, because repeating a narrow task makes a worker faster and more skilled, and it allows the business to invest in machinery suited to that one task, lowering average costs.
2. Specialisation can also let the business concentrate its resources and reputation on one product or stage of production that it does best.
3. However, specialisation also has drawbacks: workers doing the same narrow task repeatedly may become bored, which can lower motivation and the quality of work.
4. A business that relies on one specialised supplier or worker is vulnerable if that supplier or worker is unavailable, since the whole process depends on that one link.
5. Specialised workers may also find it harder to move to a different task if their job changes or disappears, since their skills are narrow rather than general.
6. Overall, specialisation is usually beneficial in terms of output and cost, but a business should weigh this against the risks of over-dependence and worker boredom before deciding how far to specialise.

Q8. Explain why earning profit alone is not usually enough as the sole purpose of a business. [4 marks]

1. A business that focuses only on profit may neglect its market standing, losing customers to competitors who offer better value or service.
2. It may also neglect innovation, falling behind rivals who improve their products or production methods.
3. Focusing only on profit can lead a business to ignore its social responsibility to employees, customers or the wider community, which can damage its reputation.
4. A damaged reputation or loss of customer trust can reduce sales in the long run, ultimately harming the very profit the business was trying to protect.

Key takeaways

• Needs are essential for survival; wants are desirable but not essential, and business activity satisfies both.
• Scarcity is the gap between unlimited wants and limited resources, and it is the basic economic problem all business activity responds to.
• Opportunity cost is the next best alternative given up whenever a choice is made, not simply the money spent.
• Specialisation raises output per worker and allows the use of specialist machinery, but can cause boredom and over-dependence.
• Specialisation between countries, based on comparative advantage, increases total output and is a reason countries trade.
• Business activity exists to use scarce resources to satisfy needs and wants, usually with profit as a leading but not the only objective.
• Added value is the difference between selling price and the cost of bought-in materials, not the same as profit.
• A business can increase added value through branding, quality, unique features, service, convenience or skilled labour.

Test yourself

What is the difference between a need and a want?

A need is essential for survival, such as food or shelter; a want is desirable but not essential for survival, such as a holiday.

Why does scarcity exist in every economy?

Because people's wants are relatively unlimited while the resources available, such as land, labour, capital and enterprise, are limited, no economy can satisfy every want.

Give an example of opportunity cost for a business owner.

If a factory is used to make bicycles, the opportunity cost is the output of any other product that could have been made using the same factory space, labour and capital instead.

Name one advantage and one disadvantage of specialisation.

Advantage: workers become faster and more skilled at a narrow task. Disadvantage: workers may become bored, and the business may depend too heavily on one specialised worker or supplier.

What is the formula for added value?

Added value equals the selling price of the product minus the cost of the bought-in materials and components used to make it.

State two objectives of a business other than profit.

Any two of: market standing, innovation, productivity, acquiring physical and financial resources, and social responsibility.

Why might branding increase added value without increasing the cost of materials?

Branding lets a business charge a higher selling price for a product that uses the same bought-in materials, so the gap between selling price and materials cost widens.