Business activity

The four factors of production

Before a business can produce anything it has to gather four kinds of resource. A market stall and a car plant need the same four, in wildly different quantities. Together they are the factors of production.

The 0264 specimen Paper 1 opens by asking you to define factors of production for 2 marks, and the mark scheme is unusually blunt about what does not count. Two marks go to a general statement along the lines of the resources a business needs in order to produce goods or services. A list of the four factors is not a definition and earns nothing on its own. So answer in two moves: say what the term means, then name the four as examples. That order is worth training, because it is how every 2-mark definition on this paper is built.

Two boundaries cause most of the confusion.

Capital is not the product. Capital is what the business uses to produce with, so the oven is capital and the loaf is not. Money held to buy equipment counts as capital too.

Enterprise is not the same as labour. The people who take orders and bake are labour, because they are paid a wage for effort. The person who risked their savings to open the bakery is supplying enterprise, and is rewarded only if there is profit left over. That is the point of the fourth factor: someone has to carry the risk that there is nothing left.

If you are revising from an older Business Studies textbook you may find whole pages on needs, wants and scarcity and on the importance of specialisation. The 0264 syllabus does not list any of those, and the factors of production sit in the space they used to occupy.

Adding value

Added value is the difference between the price a business charges for a product and the cost of the bought-in materials that went into it.

Added value per unit = selling price - cost of bought-in materials

A sandwich shop buys bread, filling and packaging for $1.20 and sells the finished sandwich for $3.50.

Added value per sandwich = 3.50 - 1.20 = $2.30

If it sells 400 sandwiches a day:

Total added value = 400 x 2.30 = $920 per day

Added value is not profit. The $920 still has to cover wages, rent, electricity and everything else that is not a bought-in material. A business can have healthy added value on every unit and still make a loss, which is exactly the situation a data-response question likes to hand you.

There are only two ways to increase added value, and both are examinable: raise the price without raising the material cost, or cut the material cost without cutting the price.

The sandwich shop lifting its price to $3.80 raises added value per unit to 3.80 - 1.20 = $2.60, but only if customers still buy 400. This is why an answer that stops at "it can raise the price" is incomplete. Say what happens next: raising the price adds $0.30 per sandwich, but if 60 customers a day go elsewhere, the shop sells 340 and takes 340 x 2.60 = $884, which is less than the $920 it started with. That is the shape of an analysis mark.

Opportunity cost

Opportunity cost is the next best alternative given up when a choice is made.

Resources are limited, so choosing one use of them means abandoning another. A bakery with $30,000 to spend that buys a second oven has given up the shop refit it could have had instead. The opportunity cost is the refit, not the $30,000.

Three points separate a 2-mark answer from a 1-mark one.

• It is the next best alternative, one thing, not a list of everything the money could have bought.
• It is what is given up, not what is chosen.
• It applies to time and to any other scarce resource, not only money. A manager who spends Thursday training staff gives up whatever else Thursday could have done.

Opportunity cost is the reason business decisions are worth arguing about. When a question asks whether a business should buy new machinery, half of the answer is what the money would otherwise have done. If the alternative was clearing an overdraft that is costing $4,000 a year in interest, the machinery has to beat that, not merely be useful.

Writing this topic for the marks

Topic 1.1 supplies definitions that get used everywhere else on the paper, so the marks lost here are usually application marks rather than knowledge marks.

Application means using the stem, not naming it. "The business uses capital" is knowledge dressed up. "The two ovens and the refrigerated van are its capital" is application, because it points at something in the case study that could not be true of a different business.

Analysis is the next step in the same chain, not a second example. Take one point forward: cheaper flour cuts the material cost per loaf, which raises added value per loaf, which gives the bakery more to put towards its fixed rent. Adding a second unconnected factor of production instead earns another knowledge mark and no analysis mark.

Evaluation is a decision with a reason attached. If asked whether the bakery should raise prices to increase added value, decide, then say what the decision rests on: how loyal its customers are, or whether a rival opened on the same street last month. A conclusion that lists advantages and disadvantages again and then stops earns nothing.

Common mistakes

• Defining factors of production by listing land, labour, capital and enterprise. The list is examples, not a definition, and the specimen mark scheme refuses it.
• Calling the finished product capital. Capital is what the business produces with.
• Treating the owner as labour, or treating employees as enterprise.
• Saying added value is profit. Added value ignores wages, rent and every other cost that is not a bought-in material.
• Working out added value from total costs instead of from the cost of bought-in materials.
• Saying a business can raise added value by raising the price, without saying what happens to the number of customers.
• Giving opportunity cost as the money spent rather than the alternative given up.
• Listing several alternatives as the opportunity cost. It is only the next best one.
• Answering a question on adding value with a definition of value for money, which is a different idea.

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