0450 NOTES

MR KELVIN OBASANJO
A need is a good or service essential for living.
A want is a good or service which people would like to have, but which is not essential for living.
People’s wants are unlimited.
The economic problem – there exist unlimited wants but limited resources to produce the goods and
services to satisfy those wants. This creates scarcity.

The economic problem – the real cause

Definitions to learn
Factors of production are those resources needed to produce goods or services.
There are four factors of production and they are in limited supply.
Scarcity is the lack of sufficient products to fulfil the total wants of the population

The real cause of the shortage or scarcity of goods and services is that there are not enough factors of
production to make all of the goods and services that the population needs and wants.
There are four factors of production:
» Land – this term is used to cover all of the natural resources provided by
nature and includes fields and forests, oil, gas, metals and other mineral
resources.
» Labour – this is the number of people available to make products.
» Capital – this is the finance, machinery and equipment needed for the
manufacture of goods.
» Enterprise – this is the skill and risk-taking ability of the person who brings
the other resources or factors of production together to produce a good
or service, for example, the owner of a business. These people are called
entrepreneurs.

Limited resources: the need to choose

Definitions to learn
Opportunity cost is the next best alternative given up by choosing another item.
We do not have the resources to satisfy all our wants, so the next best alternative that we give up becomes
our opportunity cost.
The importance of specialization and division of labour: the best use
of limited resources
Definitions to learn
Specialisation occurs when people and businesses concentrate on what they are best at.
Division of labour is when the production process is split up into different tasks and each worker performs
one of these tasks.
It is a form of specialisation.

Specialisation is now very common because:

» specialised machinery and technologies are now widely available
» increasing competition means that businesses have to keep costs low
» most people recognise that higher living standards can result from being
specialised.
The purpose of business activity
Definitions to learn
Businesses combine factors of production to make products (goods and services) which satisfy people’s
wants.
We have identified the following issues:
» People have unlimited wants.
» The four factors of production – the resources needed to make goods – are in limited supply.
» Scarcity results from limited resources and unlimited wants.
» Choice is necessary when resources are scarce. This leads to opportunity cost.
» Specialisation improves the efficient use of resources.

Business activity therefore:

» combines scarce factors of production to produce goods and services
» produces goods and services which are needed to satisfy the needs and wants of the population
» employs people as workers and pays them wages to allow them to consume products made by other
people.

Added value
Definitions to learn
Added value is the difference between the selling price of a product and the cost of bought-in materials
and components.
Example:

» The selling price of a newly built house is $100 000.

» The value of the bought-in bricks, cement, wood and other materials was $15 000.

» The added value of the building firm was $85 000. This is not all profit – out of

this the builder must pay wages and other costs too.

Why is added value important?

Added value is important because sales revenue is greater than the cost of materials bought in by the
business. This means the business:
» can pay other costs such as labour costs, management expenses and costs including advertising and power
» may be able to make a profit if these other costs come to a total that is less than the added value.

How could a business increase added value?

Stages of economic activity

The primary sector of industry extracts and uses the natural resources of Earth to produce raw materials
used by other businesses.
The secondary sector of industry manufactures goods using the raw materials provided by the primary
sector.
The tertiary sector of industry provides services to consumers and the other sectors of industry.

Relative importance of economic sectors

Which sector of industry is most important in your country? This depends on what is meant by ‘important’.
Usually the three sectors of the economy are compared by:
» percentage of the country’s total number of workers employed in each sector or
» value of output of goods and services and the proportion this is of total national output
In some countries, primary industries such as farming and mining employ many more people than
manufacturing or service industries. These tend to be countries – often called developing countries – where
manufacturing industry has only recently been established. As most people still live in rural areas with low
incomes, there is little demand for services such as transport, hotels and insurance. The levels of both
employment and output in the primary sector in these countries are likely to be higher than in the other two
sectors. In countries which started up manufacturing industries many years ago, the secondary and tertiary
sectors are likely to employ many more workers than the primary sector. The level of output in the primary
sector is often small compared to the other two sectors. In economically developed countries, it is now
common to find that many manufactured goods are bought in from other countries. Most of the workers
will be employed in the service sector. The output of the tertiary sector is often higher than the other two
sectors combined. Such countries are often called the most developed countries.

Changes in sector importance

Definitions to learn
De-industrialisation occurs when there is a decline in the importance of the secondary, manufacturing
sector of industry in a country.
There are several reasons for changes in the relative importance of the three sectors over time:
» Sources of some primary products, such as timber, oil and gas, become depleted. This has been true for
Somalia with the cutting down of most of its forests.
» Most developed economies are losing competitiveness in manufacturing to newly industrialised countries
such as Brazil, India and China.
» As a country’s total wealth increases and living standards rise, consumers tend to spend a higher
proportion of their incomes on services such as travel and restaurants than on manufactured products
produced from primary products.
Mixed economy
Definitions to learn
A mixed economy has both a private sector and a public (state) sector.
» Private sector – businesses not owned by the government.
These businesses will make their own decisions about what to produce, how it should be produced and
what price should be charged for it. Most businesses in the private sector will aim to make a profit.
» Public sector – government (or state) owned and controlled businesses and organisations.
The government, or other public sector authority, makes decisions about what to produce and how much
to charge consumers. Some goods and services are provided free of charge to the consumer, such as state
health and education services. The money for these comes not from the user but from the taxpayer.
Objectives of private sector and public sector businesses are often different.

Which business activities are usually in the public sector? In many countries the government controls
the following important industries or activities:
» health » education » defense » public transport » water supply » electricity supply

Mixed economies – recent changes

Privatization
Many governments have changed the balance between the private sector and the public sector in their
economies. They have done this by selling some public sector businesses – owned and controlled by
government – to private sector businesses. This is called privatisation.

Reasons/benefits for privatization

1. It is often claimed that private sector businesses are more efficient than public sector businesses.
This might be because their main objective is profit and therefore costs must be controlled.
2. Also, private sector owners might invest more capital in the business than the government can
afford. Competition between private sector businesses can help to improve product quality.
Disadvantages of privatization
However
1. A business in the private sector might make more workers unemployed than a public sector business
in order to cut costs.
2. A private sector business is also less likely to focus on social objectives.
Definitions to learn
Capital is the money invested into a business by the owners.

Enterprise and entrepreneurship

Definitions to learn
Entrepreneur is a person who organises, operates and takes the risk for a new business venture.
Mark Zuckerberg ▲ Sir Richard Branson ▲ Vera Wang ▲ Jerry Wang – research on work of the following
entrepreneurs . Do they inspire you??

Characteristics of successful entrepreneurs

Contents of a business plan and how business plans assist entrepreneurs
Definitions to learn
A business plan is a document containing the business objectives and important details about the
operations, finance and owners of the new business.
Importance of a business plan
1. To help gain finance -Without this detailed plan, the bank will be reluctant to lend money to the
business. This is because the owners of the new business cannot show that they have thought
seriously about the future and planned for the challenges that they will certainly meet.
2. Careful planning reduces risk

NB. Every business plan might be different, but generally business plans contain similar headings.
The contents of a business plan will usually include the following:

CONTENTS of a business plan

1 Description of the business
Provides a brief history and summary of the business, and the objectives of the business.
2 Products and services
Describes what the business sells or delivers, and strategy for continuing or developing products/services
in the future to remain competitive and grow the business. This section may also include full details of the
product and how it is to be manufactured and distributed.
3 The market
Describes the market the business is targeting. The description should include: • total market size • predicted
market growth • target market
4 Business location and how products will reach customers Describes the physical location if applicable,
internet sales or mail order. Also describes how the firm delivers products and services to customers.
5 Organisation structure and management
Describes the organisational structure, management and details of employees required. It usually includes
the number and level of skills required for the employees.
6 Financial information
Includes: • projected future financial accounting statements for several years or more into the future; these
should include income statements and statements of financial position
7 Business strategy
Explains how the business intends to satisfy customer needs and gain brand loyalty. A summary should be
included to bring together all the points from above that should demonstrate the business will be successful.

Draw up another business plan. It should be based on your own idea for a business that is operated
within your school or college (for example, a stationery shop, confectionery store or cake shop).
Use the Case study: A business plan for Pizza Place Ltd on page 24 as an example .

Why governments support business start-ups

Most governments offer support to entrepreneurs. This encourages them to set up new businesses. There
are several reasons why this support is given:
» To reduce unemployment – new businesses will often create jobs to help reduce unemployment.
» To increase competition – new businesses give consumers more choice and compete with already
established businesses.
» To increase output – the economy benefits from increased output of goods and services.
» To benefit society – entrepreneurs may create social enterprises which offer benefits to society other than
jobs and profit (for example, supporting disadvantaged groups in society).
» Can grow further – all large businesses were small once! By supporting today’s new firms the government
may be helping some firms that grow to become very large and important in the future.

Methods of measuring business size and limitations of these methods

Who would find it useful to compare the size of businesses?
» Investors – before deciding which business to put their savings into.
» Governments – often there are different tax rates for small and large businesses.
» Competitors – to compare their size and importance with other firms.
» Workers – to have some idea of how many people they might be working with.
» Banks – to see how important a loan to the business is compared to its overall size.

Business size can be measured in a number of ways.

» number of people employed
» value of output
» value of sales
» value of capital employed
They each have advantages and limitations.
Number of people employed
This method is easy to calculate and compare with other businesses.
Limitations: Some firms use production methods which employ very few people but produce high output
levels. This is true for automated factories which use the latest computer-controlled equipment. These firms
are called capital-intensive firms – they use a great deal of capital (high-cost) equipment to produce their
output. Therefore, a company with high output levels could employ fewer people than a business which
produced less output. Another problem is: should two part-time workers, who work half of a working week
each, be counted as one employee – or two?
Value of output
Calculating the value of output is a common way of comparing business size in the same industry –
especially in manufacturing industries.
Limitations: A high level of output does not mean that a business is large when using the other methods
of measurement. A firm employing few people might produce several very expensive computers each year.
This might give higher output figures than a firm selling cheaper products but employing more workers.
The value of output in any time period might not be the same as the value of sales if some goods are not
sold.
Value of sales
This is often used when comparing the size of retailing businesses – especially retailers selling similar
products (for example, food supermarkets).
Limitations: It could be misleading to use this measure when comparing the size of businesses that sell
very different products (for example, a market stall selling sweets and a retailer of luxury handbags or
perfumes)
Value of capital employed
This means the total value of capital invested into the business.
Limitations: This has a similar problem to that of the ‘number of people employed’ measure. A company
employing many workers may use labour-intensive methods of production. These give low output levels
and use little capital equipment.

Definitions to learn
Capital employed is the total value of capital used in the business.

NB. There is no perfect way of comparing the size of businesses. It is quite common to use more than
one method and to compare the results obtained.
Why the owners of a business may want to expand the business
» The possibility of higher profits for the owners.
» More status and prestige for the owners and managers – higher salaries are often paid to managers who
control bigger businesses.
» Lower average costs
» Larger share of its market – the proportion of total market sales it makes is greater. This gives a business
more influence when dealing with suppliers and distributors, and consumers are often attracted to the ‘big
names’ in an industry.

Different ways in which businesses can grow

Definitions to learn
Internal growth occurs when a business expands its existing operations.
External growth is when a business takes over or merges with another business. It is often called
integration as one business is integrated into another one.
A takeover or acquisition is when one business buys out the owners of another business, which then
becomes part of the ‘predator’ business (the business which has taken it over).
A merger is when the owners of two businesses agree to join their businesses together to make one
business.
Horizontal integration is when one business merges with or takes over another one in the same industry
at the same stage of production.
Vertical integration is when one business merges with or takes over another one in the same industry but
at a different stage of production. Vertical integration can be forward or backward.
» Vertical merger (or vertical integration) – when one business merges with or takes over another one in
the same industry but at a different stage of production. Vertical integration can be forward – when a
business integrates with another business which is at a later stage of production (closer to the consumer) –
or backward – when a business integrates with another business at an earlier stage of production (closer to
the raw material supplies, in the case of a manufacturing business).

The likely benefits of integration

Horizontal integration
» The merger reduces the number of competitors in the industry.
» There are opportunities for economies of scale .
» The combined business will have a bigger share of the total market than either business before the
integration.

Forward vertical integration

For example, a car manufacturer takes over a car retailing business.
» The merger gives an assured outlet for its product.
» The profit margin made by the retailer is absorbed by the expanded business.
» The retailer could be prevented from selling competing models of car.
» Information about consumer needs and preferences can now be obtained directly by the manufacturer.

Backward vertical integration

For example, a car manufacturer takes over a business supplying car body panels.
» The merger gives an assured supply of important components.
» The profit margin of the supplier is absorbed by the expanded business.
» The supplier could be prevented from supplying other manufacturers.
» Costs of components and supplies for the manufacturer could be controlled.

Conglomerate integration
Definitions to learn
Conglomerate integration is when one business merges with or takes over a business in a completely
different industry.
This is also known as diversification.
Advantages of Conglomerate integration
» The business now has activities in more than one industry. This means that the business has diversified
its activities and this will spread the risks taken by the business. For example, suppose that a newspaper
business took over a social networking company. If sales of newspapers fell due to changing consumer
demand, sales from advertising on social network sites could be rising at the same time due to increased
interest in this form of communication.
» There might be a transfer of ideas between the different sections of the business even though they operate
in different industries. For example, an insurance company buying an advertising agency could benefit from
better promotion of its insurance activities as a result of the agency’s new ideas.
Problems linked to business growth and how these might be overcome
Not all business expansion leads to success. There are several reasons why business expansion can fail to
increase profit or achieve the other objectives set by managers.
Why some businesses remain small
» the type of industry the business operates in
» the market size
» the owners’ objectives.

The type of industry the business operates in

Here are some examples of industries where most businesses remain small: hairdressing, car repairs,
window cleaning, convenience stores, plumbers, catering. Businesses in these industries offer personal
services or specialised products. If they were to grow too large, they would find it difficult to offer the close
and personal service demanded by consumers. In these industries, it is often very easy for new businesses
to be set up and this creates new competition. This helps to keep existing businesses relatively small.

Market size
If the market – that is, the total number of customers – is small, the businesses are likely to remain small.
This is true for businesses, such as shops, which operate in rural areas far away from cities. It is also why
businesses which produce goods or services of a specialised kind, which appeal only to a limited number
of consumers, such as very luxurious cars or expensive fashion clothing, remain small.
Owners’ objectives
Some business owners prefer to keep their business small. They could be more interested in keeping control
of a small business, knowing all their staff and customers, than running a much larger business. Owners
sometimes wish to avoid the stress and worry of running a large business.
Causes of business failure
The main reasons why some businesses fail include the following:
» Lack of management skills – this is a common cause of new business failures. Lack of experience can
lead to bad decisions, such as locating the business in an area with high costs but low demand. Family
businesses can fail because the sons and daughters of the founders of a business do not necessarily make
good managers – and they might be reluctant to recruit professional managers.
» Changes in the business environment – failure to plan for change is a feature in many of the later
chapters. This adds to the risk and uncertainty of Why new businesses are at greater risk of failing operating
a business. New technology, powerful new competitors and major economic changes are just some of the
factors that can lead to business failures if they are not responded to effectively.
» Liquidity problems or poor financial management – shortage of cash (lack of liquidity) means that
workers, suppliers, landlords and government cannot be paid what they are owed. Failure to plan or forecast
cash flows can lead to this problem and is a major cause of businesses of all sizes failing.
» Over-expansion – when a business expands too quickly it can lead to big problems of management and
finance. If these are not solved, the difficulties can lead to the whole business closing down.

Why new businesses are at greater risk of failing

Many new businesses fail due to lack of finance and other resources, poor planning and inadequate
research. In addition, the owner of a new business may lack the experience and decision-making skills
of managers who work for larger businesses. This means that new businesses are nearly always more at risk
of failing than existing, well-established businesses.
Business organisations: the private sector
There are several main forms of business organization in the private sector. These are:
» sole traders
» partnerships
» private limited companies
» public limited companies
» franchises
» joint ventures.

Sole traders
Definitions to learn
Sole trader is a business owned by one person.
– the owner is the sole proprietor.
Advantages of being a sole trader
Mike decided to start his own taxi business. He set up the business as a sole trader. These are the advantages
to Mike of being a sole trader.
• There were few legal regulations for him to worry about when he set up the business.
• He is his own boss. He has complete control over his business and there is no need to consult with or ask
others before making decisions.
• He has the freedom to choose his own holidays, hours of work, prices to be charged and whom to employ
(if he finds that he cannot do all the work by himself).
• Mike has close contact with his own customers, the personal satisfaction of knowing his regular customers
and the ability to respond quickly to their needs and demands.
• Mike has an incentive to work hard as he is able to keep all of the profits, after he pays tax. He does not
have to share these profits.
• He does not have to give information about his business to anyone else – other than the Tax Office. He
enjoys complete secrecy in business matters.

Disadvantages of being a sole trader

After operating the business for several months, Mike realised that there are also some disadvantages to
being a sole trader. He made a list of them.
1. Isolation in Decision-Making: No one to discuss or share business matters with as the sole owner.
2. Unlimited Liability: Personal assets are at risk for business debts.
3. Limited Access to Finance: Restricted to personal savings, business profits, and small loans.
4. Growth Limitations: Insufficient capital hinders expansion and economies of scale.
5. Dependence on the Owner: The business halts if the owner is unavailable; no continuity after
death.
6. Employee Limitations: Limited resources for training and career growth for workers.

Definitions to learn
Limited liability means that the liability of shareholders in a company is limited to only the amount they
invested.
Unlimited liability means that the owners of a business can be held responsible for the debts of the
business they own. Their liability is not limited to the investment they made in the business

Partnerships
Definitions to learn
Partnership is a form of business in which two or more people agree to jointly own a business.
A partnership agreement or deed of partnership is the written and legal agreement between business
partners.
It is not essential for partners to have such an agreement but it is always recommended.

Mike offered his friend Gita the chance to become a partner in his taxi business. They prepared a written
partnership agreement which contained:
• the amount of capital invested in the business by each partner
• the tasks to be undertaken by each partner
• the way in which the profits would be shared out
• how long the partnership would last
• arrangements for absence, retirement and how new partners could be admitted.

Advantages of a Partnership:
1. Increased Capital: Partners can contribute additional funds, enabling business expansion, such as
purchasing more taxis.
2. Shared Responsibilities: Duties are divided, with each partner focusing on their strengths (e.g.,
Gita handles accounts, Mike manages marketing and driving).
3. Improved Business Continuity: Absences or holidays are less disruptive as one partner is always
available.
4. Shared Risk and Motivation: Partners share both profits and losses, encouraging hard work and
collaboration.

Disadvantages of a Partnership:
1. Unlimited Liability: Partners' personal assets are at risk if the business incurs debts.
2. Lack of Separate Legal Identity: The partnership ends if one partner dies, as it is unincorporated.
3. Decision-Making Challenges: Disagreements and the need for consultation can slow decision-
making.
4. Risk of Inefficiency or Dishonesty: One partner’s poor performance or dishonesty can harm the
business and others financially.
5. Limited Growth Potential: A cap on the number of partners (usually 20) restricts the total capital
investment and scalability.
 Definitions to learn
An unincorporated business is one that does not have a separate legal identity.
Sole traders and partnerships are unincorporated businesses

Limited Partnerships (LLP) - Key Features:

1. Limited Liability: Partners are protected, and personal assets are not at risk for business debts.
2. Separate Legal Identity: The LLP continues to exist even after a partner's death, unlike ordinary
partnerships.
3. Restricted Ownership Transfer: Shares in an LLP cannot be bought or sold.
4. Continuity and Stability: The business maintains operations regardless of changes in partnership
due to death or withdrawal