Factors of Production
Businesses need resources to produce goods and services. These resources are called the factors of production.
There are four factors of production:
1. Land
→ All natural resources used by a business.
→ Includes land itself, water, forests, minerals, oil and other natural resources.
Example:
A farming business uses land to grow crops.
2. Labour
→ The physical and mental effort provided by people who work for a business.
→ Includes both skilled and unskilled workers.
Example:
→ A teacher uses knowledge and skills to provide education.
→ A factory worker uses physical effort to produce goods.
3. Capital
→ Man-made resources used to produce goods and services.
→ Includes machinery, tools, buildings, vehicles and computers.
→ Capital does not mean money itself.
Example:
A bakery uses ovens, mixers and refrigerators to produce bread and cakes.
4. Enterprise
→ The ability to organise the other factors of production and take the risks of starting and running a business.
→ The person who provides enterprise is called an entrepreneur.
→ An entrepreneur makes decisions, identifies opportunities and takes risks.
Example:
An entrepreneur may identify a demand for healthy food, invest in a restaurant and employ workers to run it.
Remember the four factors
Land → Natural resources
Labour → Human effort
Capital → Man-made resources
Enterprise → Organises resources + takes risks
Adding Value
Added value is the difference between the cost of making a product and the selling price of the product.
Formula
Added value = Selling price − Cost of bought-in materials
Example:
A bakery buys ingredients for a cake for $10.
It sells the finished cake for $25.
→ Added value = $25 − $10
→ Added value = $15
The business has increased the value of the materials by turning them into a finished product that customers are willing to pay more for.
How can a business increase added value?
A business can increase added value by:
1. Improving the product
→ Add better features or improve quality.
→ Customers may be willing to pay a higher price.
Example:
A phone company adds a better camera and longer battery life.
2. Branding
→ Create a strong and recognisable brand.
→ Customers may be willing to pay more for a branded product.
Example:
A branded sports shoe may sell for much more than a similar unbranded shoe.
3. Attractive packaging
→ Make the product look more appealing.
→ Customers may perceive it as more valuable.
Example:
Premium chocolates may use attractive gift packaging and charge a higher price.
4. Providing better customer service
→ Good service can make customers willing to pay more.
Example:
A hotel may provide 24-hour customer service, room service and free airport transfers.
5. Convenience
→ Make the product easier for customers to buy or use.
Example:
A supermarket offering home delivery may provide extra convenience to customers.
Why is added value important?
→ Higher added value can allow a business to charge a higher selling price.
→ This can increase the profit earned by the business.
→ Higher added value can help a business compete with other businesses.
Key idea:
Add value → customers perceive greater benefit → willing to pay more → higher selling price → potential for higher profit
Opportunity Cost
Businesses and individuals have limited resources but unlimited wants.
Therefore, they have to make choices.
Opportunity cost is the next best alternative that is given up when a choice is made.
Simple example
A business has enough money to:
→ Buy a new delivery van
OR
→ Buy new computer equipment
The business chooses the delivery van.
→ The computer equipment is the next best alternative given up.
→ Therefore, the opportunity cost is the computer equipment.
Business example
A business has $50,000 available.
It can:
→ Open a new shop
OR
→ Spend the money on advertising.
If it chooses to open the shop:
→ The opportunity cost is the benefit it could have gained from the advertising.
Important point
Opportunity cost is not all the alternatives that were rejected.
It is only the next best alternative.
Why is opportunity cost important to businesses?
→ Businesses have limited money, workers, time and other resources.
→ Choosing one option means giving up another option.
→ Managers should consider what they are giving up before making important decisions.
Key idea:
Limited resources → choices must be made → one option is chosen → next best alternative is given up → opportunity cost