The purpose of business activity and the factors of production
Every business, from a street food stall to a global car maker, exists to do the same basic job: it takes resources, turns them into goods (physical products such as bread or phones) or services (intangible activities such as a haircut or an insurance policy), and supplies them to customers who want them.
People have needs, which they must satisfy to survive (food, water, shelter, clothing), and wants, which they desire but could live without (a holiday, a games console).
Business activity is how a society meets those needs and wants.
What business activity sets out to achieve
The purpose of business activity is to identify what customers need and want and to satisfy it by producing goods and services.
A business does this because it hopes to gain something in return, and what it hopes to gain depends on who owns it:
- A private sector business (owned by individuals or shareholders) usually aims to make a profit, the reward its owners receive for putting their money and effort at risk.
- A public sector organisation (owned by the state, such as a state hospital or a national railway) usually aims to provide a service, often at a low price or free, funded partly by taxes.
- A social enterprise trades to make a surplus, but it uses that surplus mainly for a social or environmental purpose, such as training unemployed young people.
You will study objectives in detail in topic 1.4, and sectors in topic 1.2.
For now the key idea is this: whatever its owner wants, a business only survives if customers value its output enough to pay for it (or a government is willing to pay on their behalf).
A business that stops satisfying customers stops earning revenue.
Business activity also benefits people beyond the owners and customers.
It creates jobs and incomes for employees, orders for suppliers, and tax revenue for the government.
This is why topic 1.1.2 later links enterprise to a country's development.
The four factors of production
To produce anything, a business needs resources, which economists call the factors of production.
There are four, and Figure 1.1 shows how they come together.
Figure 1.1 The factors of production combine to produce goods and services
Factor
What it is
Business examples
Reward to the owner of the factor
Land
All natural resources: the ground itself, and what grows on it or is taken from it
a site for a shop, farmland, timber, oil, fish, water
rent
Labour
The physical and mental effort of people who work in the business
a machine operator, an accountant, a delivery driver
wages and salaries
Capital
Goods made by people and used to produce other goods and services
machinery, tools, vehicles, computers, buildings
interest
Enterprise
The skill of organising the other three factors and taking the risk of doing so
the person who starts a café and decides what to sell
profit
Three points from the table need care.
1. Capital is a man-made resource, not money. In business conversation "capital" often means the finance the owners put in (topic 5). As a factor of production, though, capital means the physical goods (an oven, a delivery van, a server) that are used again and again to make other things. Money only buys capital.
2. Labour is about quality as well as quantity. A business does not just need "workers"; it needs staff with the right skills, training and motivation. A hospital with plenty of cleaners but too few nurses is short of the labour it needs.
3. Enterprise is the factor that makes the others work. Land, labour and capital do nothing on their own. Someone has to see an opportunity, decide what to produce, hire people, buy equipment and accept the risk that the venture could fail. That someone is the entrepreneur (taught fully in 1.1.2). Enterprise is also one of the course's key concepts; learn its definition word for word from the Key terms box below.
Why the mix of factors matters
Businesses combine the factors in different proportions.
A mobile-phone assembly plant uses a lot of capital (automated lines); a hairdresser uses mainly labour; a mining company depends heavily on land.
The mix affects costs, the skills a firm must recruit and how easily it can grow.
Operations (topic 4.1) returns to this when it looks at how factors are used in the transformation process, and at labour-intensive and capital-intensive production.
Each factor is also scarce.
There is only so much farmland in a country, only so many trained engineers, only so much money to buy machines.
Because resources are limited, every business must choose how to use them, which is the subject of section 3 of this unit.
- Business activity: the process of combining resources to produce goods and services that satisfy customers' needs and wants.
- Factors of production: the resources needed to produce goods and services: land, labour, capital and enterprise.
- Land: natural resources used in production, such as sites, minerals, water and crops.
- Labour: the physical and mental effort of the people who work in a business.
- Capital: man-made goods, such as machinery, tools and buildings, used to produce other goods and services.
- Enterprise: the ability to seek out and successfully develop business opportunities.
- Enterprise as a factor of production: the skill of organising land, labour and capital and taking the risk of doing so; its reward is profit.
Define the term 'capital' as a factor of production. [2]
1. 2-mark answer: "Man-made resources, such as machines, vehicles and buildings, that a business uses to produce other goods and services." This gives the full idea (made by people, used to produce other things) and an example.
2. 1-mark answer: "Machines and equipment, like an oven in a bakery." These are examples only; they do not say what capital is, so they show partial understanding.
3. 0-mark answer: "Money that the owner puts into the business." This is the finance meaning of capital, not the factor of production.
Answer: a definition earns both marks when it states the essential idea in general terms; an example alone earns only one.
Analyse one way the quality of labour could affect the success of a private dental clinic. [5]
1. Knowledge (K 1): labour is the physical and mental effort of employees; its quality depends on their skills and training.
2. Application (APP 2): a dental clinic depends on qualified dentists and hygienists, and patients judge the clinic on the care they receive in the chair.
3. Analysis (AN, developed, 2): highly skilled dentists make fewer mistakes and treat patients more gently, so patients are satisfied and come back for check-ups. Satisfied patients recommend the clinic to friends, so the number of new patients rises without extra spending on advertising. More patients raise revenue, and because the clinic's equipment is already paid for, much of that extra revenue becomes profit.
Answer: this answer makes one point, applies it to dentistry, and builds a chain of three links (skill, then satisfaction and loyalty, then revenue and profit).
A weaker answer would say "skilled staff do a better job, so the business is more successful": that is one link with no dental context, worth about 2 of the 5 marks.
In a Define question, write the general idea first and add an example second.
The example supports the definition; it never replaces it.
For capital, the phrase "man-made" (or "made by people") and "used to produce other goods" are the two ideas that show clear understanding.
- Writing a definition that repeats the term ("enterprise is being enterprising", "labour is the labour force"). A definition that just restates the word scores 0; explain the idea in different words.
- Giving only an example as a definition ("land is a farm"). An example on its own shows partial understanding and earns 1 of 2 marks; say what land is (natural resources) and then give the example.
- Treating capital as money. As a factor of production, capital is the physical equipment that money buys.
- Saying the only purpose of every business is profit. Public sector organisations and social enterprises exist mainly to provide services or meet social aims.
Check your understanding
1. Define the term 'enterprise'. [2]
2. Identify one factor of production used by a fishing business. [1]
3. Explain one way a mountain hotel, Peak View Lodge, depends on land as a factor of production. [3]
4. Analyse one reason why a garden-design business needs capital as well as labour. [5]
5. Evaluate whether labour is the most important factor of production for a city-centre hair salon. [12]
Answers
1. 2 marks: the ability to seek out and successfully develop business opportunities (the syllabus definition; learn it word for word). 1 mark only: "starting a business" or "the person who sets up a shop", which shows partial understanding.
2. Land (or labour, or capital, for example a fishing boat). One or two words are enough; only the first answer given is marked. [1]
3. (K 1) Land is the natural resources a business uses. (APP 2) The lodge's main attraction is its mountain location and views, which guests pay a premium to enjoy, so without that site it could not charge high room rates or attract walkers and skiers.
4. (K 1) Capital is man-made equipment used to produce other goods and services. (APP 2) A garden designer needs vehicles to carry plants and soil to clients and machinery such as diggers to shape gardens. (AN 2) Without a van and digger, workers would have to move tonnes of soil by hand, so each garden would take many more days; labour costs per job would rise, and the business would complete fewer jobs a month, so its revenue would fall or its prices would have to rise above rivals'.
5. Plan. (K 2) Define labour and one other factor, such as capital or land. (APP 2) Use salon facts: stylists and colourists, a receptionist, chairs, basins and dryers, a city-centre site with office workers and shoppers nearby. (AN 2) Argue that a skilled stylist decides the quality of every cut, so satisfied clients rebook and recommend the salon, which fills the diary without extra advertising; then argue that the city-centre site (land) brings walk-in trade at lunchtimes, and that chairs, basins and dryers (capital) are needed before any appointment can take place. Evaluation (6). Judgement: labour is the most important factor for a city-centre salon, because clients choose a salon mainly for its stylists and often follow a stylist who moves, while chairs and dryers are much the same in every salon. It depends on the type of salon: a low-price walk-in salon that lives on passing trade depends more on its site, while a high-end salon depends most on its best-known stylists. The judgement is strongest where stylists hold the client relationships, since a stylist who leaves can take loyal clients with them.
- L1: Labour is the most important factor.
- L2: Labour is the most important factor because the quality of each haircut depends on the stylist.
- L3: Labour is the most important factor for this city-centre salon, because clients choose and stay loyal to individual stylists while the equipment is much the same in every salon; for a cheap walk-in salon living on passing trade, the city-centre site would matter more.