Classification of businesses | IGCSE Class 10 Business Studies Notes

This note covers how economic activities and businesses are classified: the primary, secondary and tertiary sectors, why their relative importance changes as economies develop, and how businesses are classified between the private sector and the public sector in a mixed economy.

What is meant by classifying economic activities?

Every economy contains an enormous number of different jobs and firms. To make sense of this variety, economists and business studies specialists group activities into economic sectors.

The basis used most often is the nature of the activity: whether a firm obtains a raw material directly from nature, turns that raw material into a manufactured product, or provides a service that helps other businesses or consumers.

This gives three broad groups known as the primary sector, the secondary sector and the tertiary sector.

A second basis for classification is ownership: whether a business is owned and run by private individuals and companies, or owned and run by the government. This gives the private sector and the public sector.

Both bases of classification are useful for different purposes: the first helps explain how production and employment change as an economy grows, and the second helps explain who takes the risk, who keeps the profit, and who is answerable to the public for a firm's decisions.

Definition: Economic sector. A group of businesses or activities classified together because they share a common characteristic, such as the nature of their activity or their ownership.

What is the primary sector?

The primary sector covers activities that obtain goods directly by using natural resources. The product of a primary-sector activity is a natural product rather than something manufactured.

Growing cotton depends mainly on natural factors such as rainfall, sunshine and climate, and the cotton itself is a natural product.

A dairy farm depends on the biological processes of the animals and the availability of fodder, and milk is also a natural product. Minerals and ores taken from the ground are natural products in the same way.

This sector is called "primary" because it forms the base for all the other products that are subsequently made from its output. Since most natural products come from agriculture, dairy farming, fishing and forestry, this sector is also described as the agriculture and related sector.

Definition: Primary sector. Economic activity that produces goods by directly using natural resources, such as farming, fishing, forestry and mining.

What is the secondary sector?

The secondary sector covers activities in which natural products are changed into other forms through manufacturing, the kind of process associated with industrial activity.

It is the step that comes after the primary sector: the product is not produced by nature but has to be made, so some process of manufacturing is essential.

This manufacturing could take place in a factory, a workshop, or even at home.

Using cotton fibre from the plant, workers spin yarn and weave cloth. Using sugarcane as a raw material, producers make sugar. Earth is converted into bricks, and bricks are then used to build houses.

Because this sector gradually became associated with the different kinds of industries that grew up around manufacturing, it is also called the industrial sector.

Definition: Secondary sector. Economic activity that converts natural products into manufactured goods through industrial processing, such as weaving cloth or making bricks.

What is the tertiary sector?

The tertiary sector is a third category of activity, different from the primary and secondary sectors because its activities help develop those two sectors rather than producing a good themselves.

Tertiary activities aid or support the production process. Goods produced in the primary or secondary sector often need to be transported by truck or train, sold in wholesale and retail shops, or stored in warehouses before sale.

Producers may also need to use the telephone, send letters or borrow money from banks to help production and trade. Transport, storage, communication, banking and trade are all examples of tertiary activities.

Because these activities generate services rather than goods, the tertiary sector is also called the service sector.

It also includes essential services that do not directly help production, such as the work of teachers, doctors and people providing personal services, as well as administrative and accounting work.

Newer services based on information technology, such as internet cafes, cash machines, call centres and software firms, have also become part of the tertiary sector.

Definition: Tertiary sector. Economic activity that provides services rather than goods, supporting the primary and secondary sectors as well as serving consumers directly.

Draw three linked boxes labelled Primary (Agriculture) Sector, producing natural goods; Secondary (Industrial) Sector, producing manufactured goods; and Tertiary (Service) Sector, helping to develop the other two sectors. Draw arrows between all three boxes to show that they depend on one another.

How are the three sectors interdependent?

Although the three sectors are grouped separately, they are highly interdependent. A sugar mill depends on farmers selling it sugarcane; if farmers refused to sell, the mill would have to shut down, since the secondary (industrial) sector is dependent on the primary sector for its raw material.

Equally, farmers depend on the secondary sector for the goods they buy, such as tractors, pumps and fertiliser, so a rise in the price of these goods raises the farmers' cost of cultivation and reduces their profits.

The tertiary sector depends on the other two in a similar way. People working in industrial and service jobs still need food, so if transporters went on strike and refused to carry vegetables and milk from rural areas, food would become scarce in towns while farmers would be unable to sell what they had grown.

This chain of dependence runs in all directions between the three sectors, which is why no single sector can be understood in isolation from the others.

Why does the importance of each sector change?

The relative importance of the three sectors is not fixed; it shifts as an economy develops. In the early stages of development, the primary sector is generally the most important source of production and employment, because most of the output an economy produces is natural, agricultural product.

As methods of farming improve and agriculture becomes more productive, food is produced more efficiently and fewer workers are needed on the land.

Over a long period, often more than a hundred years, new methods of manufacturing allow factories to grow, and workers move from farms into factories, so the secondary sector gradually becomes the most important in total production and employment.

Over an even longer period, a further shift takes place from the secondary to the tertiary sector, so that the service sector becomes the most important sector in terms of total production, and most working people are employed there too. This is described as the general pattern observed in developed economies.

Why is the tertiary sector important in developing economies?

In a developing economy, the tertiary sector can grow in importance for several reasons even while the primary sector still employs many people.

First, every country requires certain basic services, such as hospitals, schools, postal services, police, courts, administrative offices and defence, and in a developing country the government often has to take responsibility for providing these.

Second, as the primary and secondary sectors develop, this leads to the development of supporting services such as transport, trade and storage; the greater the development of agriculture and industry, the greater the demand for such services.

Third, as income levels rise, some sections of the population begin to demand more services such as eating out, tourism, shopping, private hospitals, private schools and professional training.

Fourth, newer services based on information and communication technology have become important and essential, and demand for them has risen rapidly.

However, not every part of the tertiary sector grows equally; a limited number of tertiary jobs employ highly skilled, well-paid workers, while a very large number of other workers, such as small shopkeepers, repair workers and transport workers, earn very little from similar-sounding tertiary activities, so it is only part of this sector that is growing strongly in importance.

How does this differ between developed and developing economies?

In developed economies, the historical pattern has generally been a steady shift of both production and employment away from the primary sector, through the secondary sector, and into the tertiary sector, so that services now dominate both output and jobs.

In many developing economies, by contrast, the shift in production away from the primary sector has not always been matched by an equal shift in employment, because not enough new jobs have been created in the secondary and tertiary sectors to absorb all the workers leaving agriculture.

As a result, a developing economy can show the tertiary sector producing the largest share of output while the primary sector still employs the largest share of the workforce, a pattern different from the fuller shift seen in developed economies.

What is a mixed economy?

An economy in which both privately owned and government-owned business enterprises exist and are allowed to operate side by side is known as a mixed economy. The economy as a whole can then be classified into two sectors on the basis of ownership: the private sector and the public sector.

In a mixed economy, the government decides, through its industrial policy, the areas in which the private sector and the public sector are each allowed to operate. The government may change this balance over time, for example by expanding government ownership in one period, perhaps to build up infrastructure that private firms are unwilling to finance, and encouraging private ownership and competition in another period.

A mixed economy therefore does not rely on one type of owner alone. Some goods and services, such as large-scale infrastructure, may be better suited to public ownership because they need heavy, long-term investment, while other goods and services, such as everyday consumer products, may be better suited to private ownership because competition between private firms can keep prices down and quality up.

The government's role is to set out, and periodically revise, where each sector is permitted to operate, so that the private sector and the public sector together meet the needs of the economy rather than competing in every single area.

Definition: Mixed economy. An economy in which both private sector and public sector enterprises exist and are permitted to carry on business activity.

What is the private sector?

The private sector consists of businesses owned by individuals or a group of individuals rather than by the government. Ownership of the assets used in the business, and responsibility for delivering whatever good or service the business sells, rests with these private owners rather than with the state.

Private sector enterprises can take several legal forms, such as a sole trader owned by one person, a partnership owned by two or more people, or a company owned by its shareholders. Whichever form is chosen, the owners provide the capital, take the business risk, and are entitled to keep the profit the business earns.

For example, a family-run bakery, a local hairdresser and a large car manufacturer owned by its shareholders all belong to the private sector, because none of them is owned by the government.

Activities in the private sector are guided mainly by the motive to earn profit: a private owner takes the risk of the business and in return keeps the reward if it succeeds, but also bears the loss if it fails. Customers normally have to pay the private owner for whatever good or service they receive, since the business depends on this revenue rather than on government funds.

Because private owners depend on profit for their own income, they generally have a strong incentive to keep costs down, respond to what customers want, and seize new business opportunities quickly, without needing approval from any outside authority before acting.

Definition: Private sector. Businesses owned and controlled by private individuals, partners or shareholders, usually operated with the aim of earning a profit.

What is the public sector?

The public sector consists of organisations owned and managed by the government, whether central government or regional government, either wholly or partly. Through these enterprises the government participates directly in the economic activity of the country.

Unlike the private sector, the purpose of the public sector is not simply to earn profit; governments raise money through taxation and other means to meet the cost of the services these enterprises provide, and they often own and run activities that the private sector would not provide at a reasonable cost, because such activities need very large sums of money, take a long time to earn a return, or are difficult to charge individual users for directly.

For example, in many countries the national railway network, the postal service and state schools and hospitals are run as public sector organisations, owned and managed by the government rather than by private shareholders.

Examples include large-scale infrastructure such as roads, railways, harbours, electricity generation and irrigation, where the private sector is unwilling to invest heavily because the returns take a long time to appear.

Definition: Public sector. Businesses and organisations owned and controlled by the government, operated to provide services for the benefit of the public rather than purely for profit.

How do the private and public sectors compare?

The clearest basis for distinguishing the two sectors is ownership: who owns the assets of the business and who is responsible for delivering the service.

In the private sector, ownership and control rest with private individuals or companies; in the public sector, the government owns the assets and is responsible for delivery.

This leads to differences in objectives, in how the business is financed, and in who is accountable for its performance.

Worked example 1. A group of entrepreneurs has $12,000 to invest in one of three business ideas, each requiring broadly similar start-up capital: (a) growing raw cotton, expected to earn $1,800 revenue and $1,500 costs a month; (b) spinning cotton into cloth in a small mill, expected to earn $3,200 revenue and $2,600 costs a month; (c) opening a dry-cleaning and laundry service in a growing town, expected to earn $4,500 revenue and $3,200 costs a month.

Classify each idea into its economic sector, calculate the monthly profit of each, and decide which idea the entrepreneurs should choose.

Answer: idea (a) is in the primary sector, with monthly profit of $1,800 − $1,500 = $300. Idea (b) is in the secondary sector, with monthly profit of $3,200 − $2,600 = $600. Idea (c) is in the tertiary sector, with monthly profit of $4,500 − $3,200 = $1,300.

Idea (c) earns the highest monthly profit, and the tertiary sector has also generally grown fastest as economies develop, so the entrepreneurs should choose idea (c), the laundry service.

Worked example 2. A country's telephone network was previously run as a state-owned monopoly charging $40 a month and serving 2 million customers, giving monthly revenue of 2,000,000 × $40 = $80,000,000. Since it was sold into private ownership, three new firms have entered the market, the price has fallen to $25 a month, and the number of customers has risen to 5 million, giving monthly revenue of 5,000,000 × $25 = $125,000,000 shared between the competing firms.

A minister must decide whether to recommend selling the state-owned postal service, which currently serves 1.5 million customers at $10 a month, on the same reasoning.

Answer: the telephone example shows that moving a service from a public sector monopoly into the private sector increased total monthly revenue from $80,000,000 to $125,000,000 while cutting the price customers pay from $40 to $25, because competition between the new firms widened customer choice and lowered prices.

On this evidence, the minister should recommend selling the postal service into private ownership, provided the government still guarantees basic postal services to remote areas that a private firm might otherwise find unprofitable to serve.

Worked example 3. A developing country needs a railway network linking its main cities, which will cost $4,000 million to build. Economists estimate the railway will not earn enough revenue to repay this cost for at least 30 years, whereas private investors in the country normally expect a project to repay its cost within 10 years.

The government must decide whether the railway should be built and run by a private firm or as a public sector enterprise.

Answer: because the railway's 30-year payback period is three times longer than the 10-year payback private investors normally require, the private sector is unwilling to take on the risk of such heavy, long-term investment.

The government should build and run the railway as a public sector enterprise, since only the state is able to raise and commit the $4,000 million needed for such large, long-term infrastructure.

Worked example 4. A family firm grows vegetables on its own small farm (a primary activity). If it sells the raw vegetables directly, it earns $0.50 a kilogram. Instead, it presses some of the vegetables into bottled juice in its own small factory (a secondary activity) and delivers the juice to local shops by van (a tertiary activity), earning $2.20 for each kilogram-equivalent of vegetables used, before deducting extra processing and delivery costs of $0.90 a kilogram.

Advise the family on how best to describe their business, and calculate the extra profit earned per kilogram by processing and delivering the juice rather than selling the raw vegetables.

Answer: processing and delivering the juice earns $2.20 − $0.90 = $1.30 net per kilogram, compared with only $0.50 per kilogram for selling the raw vegetables, an extra profit of $1.30 − $0.50 = $0.80 a kilogram.

Because the firm combines growing, processing and distribution, it should not be described as belonging to only one sector; it operates across the primary, secondary and tertiary sectors at once, and the family should choose to continue processing and delivering the juice themselves rather than selling raw vegetables, since this adds $0.80 of extra profit for every kilogram used.

Going beyond the syllabus

Some economists also separate out a fourth, quaternary sector of knowledge-based services, such as research, consultancy and information technology, from the wider tertiary sector, since these activities rely heavily on specialist skills and information rather than on routine service provision. This finer division is not always used in basic classification, but it shows how the simple three-sector model can be extended as an economy becomes more knowledge-intensive.

Governments also sometimes track how an economy is changing by watching the share of output and employment generated by this knowledge-based group of activities separately from other services such as transport, retailing or personal services, since growth in research, consultancy and software can signal a different stage of development from growth in simpler services such as shops or repair work.

Alongside this, the private-public distinction is sometimes extended further by looking at joint ventures, where a private firm and a public enterprise, or firms from two different countries, pool their resources and share the risks and rewards of a single business venture rather than operating entirely separately. This shows that ownership classification is not always a simple either-or choice between fully private and fully public, since the two can also combine in a single enterprise.

What are the merits of public sector ownership?

Judging public ownership goes beyond classifying a business, but it explains why a mixed economy keeps both sectors.

1. It can provide the heavy, long-term investment needed for infrastructure such as transport, power and irrigation, which the private sector is often unwilling to risk because returns take a long time to appear.
2. It can be used to develop regions of a country that private firms avoid because they are less immediately profitable, helping to balance development across a country.
3. It can prevent wealth and economic power from becoming concentrated in a small number of private hands, since the benefits of large-scale public enterprises are shared more widely.
4. It can guarantee that essential services, such as health, education, water supply and postal services, remain available to everyone rather than only to those who can pay a high private price.

What are the limitations of public sector ownership?

• Decisions can be slow because managers need approval from government departments before acting, which reduces the flexibility a business needs to respond quickly to markets.
• There is often political interference in management decisions, which can weaken sound business judgement.
• Public enterprises can become bureaucratic and over-cautious, so they may miss business opportunities that require fast, risk-taking decisions.
• Because losses are ultimately covered from public funds, there is less pressure to control costs tightly than in a privately owned firm that must earn its own profit to survive.

Glossary

• Primary sector: economic activity producing goods by directly using natural resources, such as farming, fishing or mining.
• Secondary sector: economic activity converting natural products into manufactured goods through industrial processes.
• Tertiary sector: economic activity providing services that support production or serve consumers directly.
• Economic sector: a group of activities or businesses classified together on a common basis, such as nature of activity or ownership.
• Private sector: businesses owned and controlled by private individuals, partners or shareholders.
• Public sector: businesses and services owned and controlled by the government.
• Mixed economy: an economy in which both private sector and public sector enterprises operate together.
• Interdependence: the reliance of one economic sector on the output or services of another.
• Developed economy: an economy with high average income where the tertiary sector is generally the largest producer and employer.
• Developing economy: an economy still industrialising, where the primary sector often still employs a large share of the workforce.
• Infrastructure: basic physical facilities, such as transport, power and water, needed for an economy to function.
• Industrial policy: government decisions setting out which activities the private sector and public sector are each allowed to carry out.

Common errors and misconceptions

• Misconception: farming is always a tertiary activity because it involves selling produce to other people. Correct: farming is a primary activity, because it obtains a good directly by using natural resources; only the transport or sale of the crop by someone else is a tertiary activity.
• Misconception: a business can only belong to one sector. Correct: a single firm can carry out primary, secondary and tertiary activities at once, for example a farm that also processes and delivers its own produce.
• Misconception: the public sector always makes a loss while the private sector always makes a profit. Correct: the public sector's main objective is usually a service rather than profit, but it can still earn revenue, while private firms can also make losses.
• Misconception: all developing economies follow exactly the pattern seen in developed economies as they grow. Correct: in many developing economies the shift of production away from the primary sector is not always matched by an equal shift in employment.
• Misconception: "industrial sector" and "secondary sector" refer to different things. Correct: the secondary sector is also described as the industrial sector, since both terms refer to manufacturing activity.
• Misconception: ownership and nature of activity are the same basis for classifying a business. Correct: primary, secondary and tertiary classify businesses by the nature of their activity, while private and public sector classify them by ownership; the two schemes can be applied to the same firm at once.

Exam-style questions with model answers

Q1. State what is meant by the "tertiary sector". [2 marks]

1. The tertiary sector is the part of the economy that provides services rather than goods.
2. It includes activities such as transport, banking and retailing that support the primary and secondary sectors or serve consumers directly.

Q2. A firm mines iron ore and sells it, without processing it further, to a steelworks. Identify the economic sector of this firm's activity and give one reason for your answer. [2 marks]

1. The firm's activity is in the primary sector.
2. This is because it obtains a good, iron ore, directly by using a natural resource, without manufacturing it into another form.

Q3. A country's government is deciding whether a new national electricity grid should be built by a private company or by a public sector enterprise, given that the project will cost a very large sum of money and will not earn a full return for many years. Explain two reasons why the government might choose to build it as a public sector enterprise. [4 marks]

1. The project requires very heavy investment, and a public sector enterprise can draw on government funds and borrowing rather than relying only on private investors who may be unwilling to commit such large sums.
2. Because the payback period is long, private firms may see the project as too risky or insufficiently profitable, whereas a public sector enterprise does not need to earn a profit to justify the investment, only to provide the service.

Q4. Distinguish between the private sector and the public sector, using an example of each. [4 marks]

1. The private sector consists of businesses owned and controlled by private individuals, partners or shareholders, such as a sole trader running a local shop.
2. The public sector consists of businesses and services owned and controlled by the government, such as a government-run railway network.
3. Private sector firms are usually guided by the aim of earning profit for their owners, whereas public sector enterprises aim mainly to provide a service, which may be funded by taxation rather than by profit.
4. Ownership and accountability also differ: private owners are accountable to themselves or their shareholders, while public enterprises are ultimately accountable to the government and the public.

Q5. A small country has, over the past forty years, seen production move mostly from the primary sector into the tertiary sector, but employment has stayed largely in the primary sector. Explain why this pattern can occur in a developing economy. [6 marks]

1. Production can move towards the tertiary sector because services such as transport, trade, banking and new technology-based services have grown rapidly as the economy develops.
2. Rising incomes also increase demand for services such as tourism, private healthcare and education, further boosting tertiary sector output.
3. However, employment may not shift to the same extent because not enough new jobs have been created in the secondary and tertiary sectors to absorb workers leaving the primary sector.
4. As a result, many workers remain in primary sector activities such as farming even though these activities now produce a smaller share of total output.
5. This means a developing economy can show a large gap between the sector that produces most output and the sector that employs most workers, unlike the fuller shift from primary through secondary to tertiary seen in developed economies.

Q6. Explain two reasons why the private sector might be unwilling to provide a particular good or service that the public sector then provides instead. [4 marks]

1. The activity may require a very large amount of investment, more than most private firms can afford or are willing to risk on their own.
2. The return on the investment may take a long time to appear, so private investors may prefer projects with quicker, more certain profits, leaving the government to provide the service instead.

Q7. Evaluate whether selling a state-owned national bus company into private ownership would benefit its passengers. [6 marks]

1. Selling the bus company could increase competition if other private operators also enter the market, which may lead to lower fares and a wider choice of routes and timetables for passengers.
2. A private owner, aiming for profit, may also invest in newer vehicles and more efficient scheduling to attract more customers.
3. However, a private owner may withdraw unprofitable routes, such as those serving remote areas, reducing service for some passengers even if overall efficiency rises.
4. A public sector bus company, by contrast, can be required to run routes that serve the public interest even where they make a loss, because its objective is service rather than profit.
5. Overall, passengers on busy, profitable routes are likely to benefit from privatisation through lower fares and better service, while passengers on quieter routes may be at risk of losing services unless the government protects them through a separate agreement.

Key takeaways

• Economic activities can be classified by the nature of the activity into primary, secondary and tertiary sectors.
• The primary sector produces natural goods directly from resources such as land, water and minerals.
• The secondary sector manufactures natural products into other forms through industrial processes.
• The tertiary sector provides services that support production or serve consumers and businesses directly.
• The three sectors are highly interdependent, since each relies on the others for inputs, sales or support.
• As economies develop, importance generally shifts from the primary sector towards the secondary and then the tertiary sector.
• In many developing economies the shift in employment lags behind the shift in production between sectors.
• Businesses can also be classified by ownership into the private sector and the public sector.
• A mixed economy contains both private sector and public sector enterprises operating alongside each other.
• Public ownership can provide heavy, long-term infrastructure investment that private firms may be unwilling to risk, but it can also suffer from slower decision-making and political interference.

Test yourself

Which sector does fishing belong to, and why?

Fishing belongs to the primary sector, because it obtains a natural product, fish, directly by using a natural resource rather than manufacturing anything.

Why is the secondary sector also called the industrial sector?

Because it covers manufacturing activities, carried out in factories, workshops or at home, that turn natural products into other forms through industrial processing.

Give one example of a tertiary sector activity and explain why it is tertiary rather than secondary.

Banking is a tertiary activity because it provides a service, lending and managing money, rather than producing or manufacturing a physical good.

What is the main difference between the private sector and the public sector?

Ownership and objective: the private sector is owned by individuals or shareholders aiming mainly for profit, while the public sector is owned by the government aiming mainly to provide a service.

What is a mixed economy?

An economy in which both private sector businesses and public sector enterprises exist and are allowed to operate together.

Why might a government keep a loss-making railway network in the public sector rather than sell it?

Because the railway may provide an essential service to the public, and the government may judge continued service more important than making a profit.

Why has the shift in employment away from the primary sector often been smaller than the shift in production in developing economies?

Because not enough new jobs have been created in the secondary and tertiary sectors to absorb all the workers who would otherwise leave agriculture.