Business · 1 Understanding business activity

1.1.1 The nature of business activity

Before you start

You can subtract one amount from another.
You understand that a business uses resources to produce goods or provide services.

Syllabus objectives covered (3)

factors of production: land, labour, capital and enterprise
concept of adding value and how added value can be increased
concept of opportunity cost

Part 1 of 4

The resources a business brings together

Imagine you run a bakery. You need resources to turn ingredients into bread. The resources used to produce goods and services are called factors of production.
Land means natural resources. Wheat grown in soil and water used in making bread depend on natural resources. Land includes more than the ground beneath a business: forests, minerals and rivers are also examples.
Labour means human physical and mental effort used in production. When you knead dough or plan baking times, you provide labour.
Capital means human-made resources used in production. Your oven, mixer and tools are capital because they help you produce bread. Capital also includes the finance (money) used to set up the business and buy these resources, so 'the money the owner invests' is a valid example of capital too.
Enterprise brings the other factors together and takes the risk of running the business. If you decide which bread to sell, arrange the resources and risk losing the money invested, you provide enterprise.
Classify the resource by its role. A baker provides labour; an oven is capital. A building is capital because people made it, while the natural site beneath it is land. One person can provide both labour and enterprise.

Part 2 of 4

What added value measures

A customer may pay more for a finished loaf than the bakery paid for the materials used to make it. The difference is added value: the value the business adds to bought-in materials and components.
Calculate added value by subtracting the cost of bought-in materials and components from the selling price. Use amounts for the same unit or the same quantity.
$Added value = Selling price - Cost of bought-in materials and components$
In this lesson, all money amounts are in GBP. A loaf sells for GBP 5 and uses bought-in materials costing GBP 2. The added value is GBP 3 per loaf.
Do not treat that GBP 3 as profit. It must also help cover costs such as wages and rent. Added value does not subtract every cost of running the business.

Part 3 of 4

How you can increase added value

You can raise the selling price while keeping the cost of bought-in materials unchanged. Better quality, convenient service or a distinctive product may give customers a reason to pay more. A higher price only increases added value if customers are still willing to buy at that price.
You can reduce the cost of bought-in materials while keeping the selling price unchanged. Negotiating a lower supplier price or using less material through reduced waste can increase the difference.
A change can affect both sides of the calculation. If improved packaging raises the selling price by GBP 2 but raises bought-in costs by GBP 1, added value increases by GBP 1 per item.
Check the effect on quality. Cheaper materials may reduce what customers will pay, so a lower bought-in cost does not guarantee higher added value. Compare the new difference with the old difference.

Part 4 of 4

The best alternative you give up

Your resources are limited, so choosing one use can prevent another. Opportunity cost is the next best alternative forgone when you make a choice.
Suppose your bakery has room for either a new oven or a display counter, but not both. If you choose the oven and the counter is your best rejected option, the counter is your opportunity cost.
If several alternatives are available, opportunity cost is only the best one you reject. It is not a list of everything you cannot have.
Separate the payment from the opportunity cost. The oven has a money price, but its opportunity cost is the next best use of the resources you commit to it. You can express that alternative as a benefit forgone when the question provides enough information.

Worked examples

Example 1. A fictional bakery uses water from a natural spring, a baker’s work and a mixing machine. Its owner arranges production and accepts the risk of a loss. Identify the four factors of production represented.

Show the working

The natural spring water represents land because it is a natural resource.
The baker’s effort represents labour because it is human work.
The mixing machine represents capital because it is human-made equipment used in production.
The owner’s organising and risk-taking represent enterprise.

Answer: Land: natural spring water. Labour: the baker’s work. Capital: the mixing machine. Enterprise: the owner’s organising and risk-taking.

Example 2. A fictional bakery sells a cake for GBP 18. Bought-in materials and packaging cost GBP 7 per cake. A new design allows a selling price of GBP 21, but raises those bought-in costs to GBP 8. Calculate the added value per cake before and after the change, and the increase.

Show the working

Subtract the original bought-in cost from the original selling price because added value measures this difference.
$18 - 7 = 11$
Use both new figures for the redesigned cake so you compare like with like.
$21 - 8 = 13$
Subtract the original added value from the new added value to find the increase.
$13 - 11 = 2$

Answer: Original added value: GBP 11 per cake. New added value: GBP 13 per cake. Increase: GBP 2 per cake. This is an increase in added value, not a calculation of profit.

Example 3. You can use one free afternoon for only one activity: a revision session, a paid bakery shift or a sports session. You choose revision. Of the rejected options, you prefer the paid shift to sport. Identify your opportunity cost and explain why.

Show the working

Your chosen activity is revision, so it is not the opportunity cost.
The paid shift is your preferred rejected option. This makes it the next best alternative forgone.
Do not add sport to your answer. It is a rejected option, but it is not the next best one.

Answer: The paid bakery shift is the opportunity cost because it is the next best alternative you forgo by choosing revision.

Where people go wrong

Mistake: Calling every resource on a business site land.

Instead: Separate natural resources from human-made productive resources.

The site is land; the building and equipment are capital.

Mistake: Treating an owner as enterprise regardless of the activity described.

Instead: Link enterprise to organising resources and taking business risk.

An owner doing production work also supplies labour. The role in the question determines the classification.

Mistake: Calling selling price minus bought-in materials profit.

Instead: Call this difference added value.

Other business costs, such as wages and rent, have not yet been deducted.

Mistake: Assuming a higher selling price always increases added value.

Instead: Compare the change in price with the change in bought-in costs.

If bought-in costs rise by more than the selling price, added value falls.

Mistake: Giving the money spent or every rejected option as opportunity cost.

Instead: Identify the next best alternative forgone.

Opportunity cost concerns the best alternative use you sacrifice, rather than the payment alone or all rejected uses.

Check yourself

Identify the factor of production represented by timber from a forest and the factor represented by a delivery van used by a bakery.
Answer
Timber from a forest: land. Delivery van: capital.
Explain why the same bakery owner can provide both labour and enterprise.
Answer
The owner provides labour when doing physical or mental production work. The owner provides enterprise when organising resources and accepting business risk. Equivalent examples and wording are valid.
A loaf sells for GBP 6 and its bought-in materials cost GBP 2. Calculate added value per loaf.
Answer
GBP 4 per loaf: $6 - 2 = 4$ .
A cake sells for GBP 16 with bought-in costs of GBP 6. A redesign raises the price to GBP 19 and bought-in costs to GBP 10. Calculate added value before and after the redesign and the change.
Answer
Before: GBP 10 per cake ( $16 - 6 = 10$ ). After: GBP 9 per cake ( $19 - 10 = 9$ ). Added value falls by GBP 1 per cake ( $9 - 10 = - 1$ ).
A bakery can buy either a mixer or a display cabinet. It chooses the mixer. The cabinet is its next best alternative. Identify the opportunity cost.
Answer
The display cabinet forgone, or the benefits from that cabinet that the bakery gives up.
Define opportunity cost.
Answer
The next best alternative forgone when a choice is made. An equivalent precise definition is valid; an example alone is not a definition.

Exam questions

Try each part first. Open the mark scheme after you have written your answer.

Question 1. All businesses and figures in these questions are fictional. Noor runs a bakery using water from a natural spring, bakers who mix dough, and electric ovens. Noor organises these resources and takes the risk of a loss.

(a) Identify one example from Noor’s bakery for each of the four factors of production: land, labour, capital and enterprise. Give one answer for each factor. 4 marks No calculator

Mark scheme

pt1 Land: water from the natural spring / the natural spring supplying it. Mark only the first answer offered for land.
pt1 Labour: the bakers / the bakers’ effort in mixing dough. Mark only the first answer offered for labour.
pt1 Capital: the electric ovens. Mark only the first answer offered for capital.
pt1 Enterprise: Noor’s organising resources and taking risk / Noor in the entrepreneurial role described. Mark only the first answer offered for enterprise. Across this part, accept equivalent wording and every other valid contextual response that fits the requested factor; do not credit repetition as a different factor without a valid distinct role.

Question 2. Noor’s bakery sells a cake for GBP 24. Bought-in ingredients and packaging cost GBP 9 per cake. Noor could offer celebration designs using the same ingredients, or negotiate with the supplier for a lower ingredient price. No outcomes from these options are guaranteed.

(a) Calculate the current added value per cake. 2 marks

Mark scheme

pt1 Correct method: selling price minus bought-in materials and components, giving $24 - 9$ . Award this method mark if the method is correct but the arithmetic answer is wrong.
pt1 Correct answer: GBP 15 per cake. A correct answer alone earns both marks. Accept equivalent valid working. Apply the own figure rule to any correctly completed method using an earlier candidate figure where relevant.

(b) Explain two ways Noor could increase added value per cake. 6 marks No calculator

Mark scheme

k1 First distinct valid way: raise selling price / reduce bought-in costs. Other valid methods that widen the difference are acceptable.
app1 Relevant application of the first way: for example, celebration designs using the same ingredients, or negotiation with the bakery’s ingredient supplier. The detail must support the stated method.
an1 Relevant development of the first way: for example, customers willing to pay more for celebration designs raise the selling price without a matching rise in bought-in costs, widening added value per cake.
k1 Second distinct valid way: for example, reduce bought-in costs if raising price was the first way. Accept all valid responses, including distinct practical methods, with no double credit for repetition.
app1 Relevant application of the second way: for example, negotiate a lower price for the ingredients in Noor’s cakes, or reduce waste of bought-in cake ingredients.
an1 Relevant development of the second way: for example, a lower ingredient cost with the cake price unchanged leaves a greater difference per cake. Accept equivalent wording and any correct contextual chains of reasoning for either way; the illustrative points are not compulsory. Do not award analysis merely for saying profit rises.

Question 3. Noor has enough space for either another oven or a display cabinet, but not both. Noor chooses the oven. The display cabinet is the next best alternative use of this space. The oven would allow more bread to be baked at once. The cabinet would allow cakes to be displayed to customers.

(a) Define opportunity cost. 2 marks No calculator

Mark scheme

pt2 Award 2 marks for clear understanding: the next best alternative forgone when making a choice. Award 1 mark for some understanding, such as an alternative given up, without making clear that it is the next best. Award 0 for examples alone. Accept every equivalent precise definition; monetary wording can earn credit if it correctly expresses the value of the next best alternative forgone. (accept all valid responses)

(b) Outline two consequences of Noor’s choice: one involving the oven and one involving the alternative forgone. 4 marks No calculator

Mark scheme

k1 A valid consequence of the chosen use, such as gaining additional production capacity. Accept all valid responses consistent with the stem.
app1 Relevant application: the extra oven allows Noor to bake more bread at once. Equivalent contextual links to the chosen oven earn credit.
k1 A valid consequence of forgoing the next best alternative, such as losing the benefit of additional display space. Accept equivalent valid consequences of the sacrifice.
app1 Relevant application: Noor forgoes the cabinet for displaying cakes to customers. Accept equivalent contextual applications. Credit distinct valid consequences without requiring the illustrative wording; do not credit repeated or mirror statements twice.

How this is examined

Why a change can increase added value: An Explain two ways task, as in this lesson’s 6-mark practice part. For each way, give a valid method, connect it meaningfully to the business, and explain how it widens selling price minus bought-in costs. For example: pre-ordered celebration cakes may sell for more using the same ingredients, so added value per cake rises if the price rises while bought-in costs stay unchanged. Accept other valid contextual explanations.
Which resources are land, labour, capital and enterprise: An Identify four task, as in this lesson’s 4-mark practice part. Give one appropriate resource for each named factor. A natural resource is land; human effort is labour; human-made equipment or the finance invested is capital; organising and risk-taking is enterprise. Only the first answer for each requested factor is marked.
What you sacrifice when resources have another use: A Define task, as in this lesson’s 2-mark practice part. Define opportunity cost as the next best alternative forgone. Both the ranking of the alternative and its sacrifice matter. An example alone does not define it.
The difference between selling price and bought-in costs: A Calculate task, as in this lesson’s 2-mark practice part. Recall $Added value = Selling price - Cost of bought-in materials and components$ . Use figures for the same quantity, and state the answer per item with its currency so it is clear. A correct answer alone earns both marks; a correct method with an incorrect answer earns one. Write the formula before substituting the figures so your method is clear.

Words to know

Factors of production: The resources used to produce goods and services: land, labour, capital and enterprise.
Land: Natural resources used in production.
Labour: Human physical and mental effort used in production.
Capital: Human-made resources used to produce goods and services, such as machinery, tools and buildings, and the finance needed to set up and run a business.
Enterprise: Organising the other factors of production and taking the risk of running a business.
Added value: The difference between selling price and the cost of bought-in materials and components.
Opportunity cost: The next best alternative forgone when a choice is made.

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