Business Section 1: Understanding Business Activity

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What is the purpose of a business?

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What is the purpose of a business?

To combine factors of production to make products that satisfy people’s needs and wants

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Products that you can physically touch (tangible)

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Work that supports a business but does not produce a tangible commodity (intangible)

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  • A good/service that is essential to living to aid life progress

    • Water, food, clothing, shelter

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  • A good or service which people would like to have but is not necessary for survival

  • Wants are unlimited

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Basic economic problem

Unlimited wants + limited resources = scarcity

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  • A shortage of a resource

  • Lack of sufficient products to fulfill the total wants of a population

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The ‘real’ cause to the economic problem

Not enough factors of production to make all of the goods and services that the population needs/wants (they are in limited supply)

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Factors of production

Resources needed to produce goods and services

  • Land, labour, capital, enterprise

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  • All raw materials and natural resources

    • Trees, fossil fuels

  • Physical land

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The number of workers who contribute to the production of goods and services

  • Skills of people

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Finance, investments, machinery- needed for the manufacture of goods

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  1. The skill + risks taken by an entrepreneur to make a profit

  2. Bringing together the factors of production → to produce a good/service

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Opportunity Cost

The next best alternative given up by choosing another item

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When individuals and businesses concentrate on what they are best at

  • This improves the efficient use of resources

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Division of labour

Production process is split up into different tasks + each specialised worker performs 1 of these tasks

  • Form of specialisation

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Advantages of division of labour

(3 points)

  1. Increased efficiency + output as the worker does the same task repeatedly

  2. Save time → less time is wasted moving from one workbench to another

  3. Quicker + cheaper to train workers → fewer skills need to be taught

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Disadvantages of division of labour

(2 points)

  1. Decreased efficiency → workers become bored doing just 1 job

  2. Production is stopped if 1 specialised employee is absent (no one else can do the job)

    • If you have multiple people specializing in the same role it is not cost-effective

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What causes opportunity cost?

Choices need to be made due to not having the resources to satisfy all wants

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What does business activity do?

(3 points)

  • Combines scarce factors of production to produce goods and services

  • Produces goods + services that satisfy the needs and wants of a population

  • Employs people as workers + pays them wages → allows them to consume products made by other people

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Added value

The difference between the selling price of a product and the cost of bought-in materials per unit

  • Extra features/enhancements a company gives to a product before offering it to customers


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What happens if businesses don’t add value?

(2 points)

  • Other costs cannot be paid for (labour, rent)

  • No profit will be made

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How do you calculate added value?

Selling price of a product - Cost to make the product = Value added

<p><mark data-color="green">Selling price of a product - Cost to make the product = Value added</mark></p>
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Why is added value different to profit?

  • AV doesn’t include rent and staff wages

    • If a car sells for £10,000 and the cost of materials is £3,000, the value added is £7,000

  • After the deduction of paying rent on the building the car was made in, staff wages, and bills = profit

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Ways in which a business can increase added value

(2 points)

  1. Increase the selling price but keep the cost of materials the same

    • A business must create a higher-quality image for its product or service

  2. Reduce the cost of materials but keep the selling price the same

    • But cheaper materialsreduces the quality of the product

    • Customers may not be willing to pay the same price for a lower-quality product

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How can you add value to a product?

(6 points)

  1. Branding- desirable brand, people willing to pay higher prices

  2. Quality- good quality products/personal service adds value

  3. Product features- consumers pay higher prices for additional features

  4. Convenience- customers pay higher prices to save time

  5. After-buy service: where firms provide support for the product if something goes wrong for an additional cost

  6. Customization: allows the customer to personalise the product so it suits them best

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Why do businesses add value?

(5 points)


  • Meet customers’ needs

  • So they can charge a higher price

  • Be different from the competition

  • Create customer loyalty

  • Focus the business on its target market

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The resources + wealth of a country

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How are businesses classified?

  1. Primary sector

  2. Secondary sector

  3. Tertiary sector

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Primary sector

Extracts and uses the natural resources from the earth to produce raw materials used by other businesses

  • Farming, fishing, and forestry

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Secondary sector

Manufacturing goods using raw materials from the primary sector

  • Extracted resourcesusable goods

    • Car manufacturing and construction

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Tertiary sector

Provides finished goods + services to consumers + the other sectors of the industry

  • Transport, banking, retail, hotels

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Chain of production

The process that a product moves through to get from raw materials to final consumer goods

  • Primary productionSecondary productionTertiary production

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How is the importance of economic sector in a country determined

(2 points)

  • % of the country’s total workers employed in each sector

  • Sector with the most valuable output of goods/service

    • The proportion this is of total national output

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Developed countries

  • Manufacturing is imported/conducted with high standards

  • Levels of employment are highest in the tertiary sector

  • High income, levels of productivity, investment

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Developing countries

  • Low incomes and low levels of saving

  • Levels of employment and output are highest in the primary sector

  • Manufacturing is recently established

  • Minimal demand for services like transport as most people live in rural areas

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How are countries classified?

By size of different sectors of business activity

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The growing importance of the secondary sector in an economy

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The decline of manufacturing sector + the growing importance of the tertiary sector

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Disadvantages of de-industrialisation

(3 points)

  • Loss of jobs in rural areas

  • Break-up of rural communities → people move to cities to find work

  • Need to clean up old industrial sites (demolish old buildings, remove toxic waste)

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Why does the importance of sectors change

(3 points)

  1. Sources of primary products (raw materials) become scarce

  2. Developed economies are less competitive in secondary manufacturing

    • Factory costs (usually wages) are too high e.g., wages in China/India are cheaper

  3. People spend more on the tertiary sector rather than secondary as they become wealthier

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Mixed economy

When a country has a private and a public sector

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Private sector

(4 points)

Businesses owned and controlled by individuals/shareholders (not the government)

  • Goal = make profit

  • Funds come from the owner’s savings or shareholders

  • Goods are for paying customers

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Advantages of the private sector

(3 points)

  1. Goal = profit → so high efficiency + lower costs

  2. Competition is encouraged (prices will be lower)

  3. Private sector owners can invest more capital in the business than the government can afford

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Disadvantages of the private sector

(2 points)

  1. Levels of unemployment are higher in order to cut costs + improve efficiency

  2. Some services may be closed (run out of money)

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Public sector

(5 points)

Government owns + controls the business

  • Goal = non-profit, benefit society

  • Some services provided are free

  • Provide services (some free) to the public → to benefit society rather than making a profit

  • The money comes from the taxpayer (not the user)

    • Health, education,etc

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When the government sells public sector businesses to the private sector

  • Same advantages of private sector

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A person who organises and takes the risk for a new business venture

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Advantages of being an entrepreneur

(5 points)

  • Independence: you can choose how to use time and money

  • May become successful if the business grows

  • May be profitable: the income can be higher than working as an employee for a firm

  • Can make use of personal skills + put own ideas into practice

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Disadvantages of being an entrepreneur

(4 points)

  • Risk: many new entrepreneurs’ businesses fail due to poor planning

  • Capital: they must put their own money into the business and find other sources of capital

  • Lack of knowledge and experience in operating a business

  • Opportunity cost: lost income from not being an employee of another business

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Characteristics of successful entrepreneurs

  1. Hard-working – Long hours of work needed to become successful

  2. Risk-taker – Entrepreneurs never know if a business idea will succeed

  3. Creative – Business ideas different from competitors

  4. Self-confident – To convince banks and investors.

  5. Effective communicator – Talk clearly to banks, customers, and employees about business

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Business plan

A document containing the business objectives + important information

  • Business operations, finance, + owners

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Uses of a business plan

(2 points)

  • To gain finance (needed to apply for loans)

  • Reduces risk of failure

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What would happen without a business plan?

Banks would be reluctant to lend money to the business

  • Owners of the new business cannot show that they have thought about the future and planned for challenges they would meet

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Advantages of a business plan

(4 points)

  • Easier to run- by documenting various details

  • Low chance of losing sight of the mission → objectives have been written down

  • Helps motivate employees- business objectives are set

  • A new entrepreneur will find it easier to get a loan

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Contents of a business plan

(7 points)

  1. Products and services you will sell

  2. Market

  3. Business location, how products will reach customers

  4. Financial information

  5. Business strategy

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‘Description of the business’ in a business plan

Brief history and summary of the business and their objectives

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Why do governments support business start-ups?

(5 points)

  1. Reduce unemployment: new businesses create job opportunities

  2. Increase competition: prices are lowered

  3. Increase output of goods: benefits economy

  4. Benefit society: social enterprises offer benefits to society other than jobs + profit

  5. Can grow larger: + contribute to country

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How governments support business start ups

  1. Loans at low-interest rates

  2. Land to set up businesses at low costs

  3. Grants (money) to train employees

  4. Use research facilities at public universities

  5. Business advice from experts

<ol><li><p>Loans at low-interest rates</p></li><li><p>Land to set up businesses at low costs</p></li><li><p>Grants (money) to train employees</p></li><li><p>Use research facilities at public universities</p></li><li><p>Business advice from experts</p></li></ol>
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Who and why would they find it useful to compare the size of businesses?

(5 points)

  1. Investors: before deciding which business to put their savings into

  2. Governments: different tax rates for small + large businesses

  3. Competitors: to compare their size with other firms

  4. Workers: to know how many people they are working with

  5. Banks: to see how important a loan is to a business compared to its overall size

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How can business size be measured?

(4 points)

  • Number of employees

  • Value of output

  • Value of sales

  • Value of capital employed

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Limitations of measuring business size by number of employees

(2 points)

  • Some firms produce higher output with fewer employees (capital-intensive firms)

    • They use a lot of capital at a high cost

  • Should two part-time workers be counted as one employee or two?

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Value of output

How much a business is earning from selling its products (sales/revenue turnover)

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Limitations of measuring business size by the value of output

The value of output in a time period may not be the same as the value of sales if some goods are not sold

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Value of sales

The price of products/services sold per unit

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Limitations of measuring business size by the value of sales

Misleading when comparing businesses that sell very different products

  • Luxury brands require fewer sales than an average firm to make the same profit

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Value of capital employed

The value of long-term finance invested in a business to buy assets like factories

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Limitations of measuring business size by the value of capital employed

Inaccurate- businesses have different methods of production

  • Some firms invest higher amounts into machinery than others (labour intensive) with fewer employees (capital-intensive firms)

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Market share

The % of total market sales held by one brand/business

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Limitations of measuring business size by market share

The size of the market each business operates in is very different

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Why do businesses grow?

(4 points)

  1. Higher profits

  2. More status for owners + employees → higher salaries due to control of larger businesses

  3. Economies of scale result in lower average costs

  4. Larger market share

    • Firms: more influence when dealing with suppliers

    • Customers are attracted to ‘big names’ in an industry

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Economies of Scale

A reduction in average costs as a business increases in size as production becomes more efficient

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Internal growth

When a business expands its existing operations by increasing production or through new markets

  • Slow but easier to manage

  • Growth is paid for by profits of the existing businesses

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External growth

Merger or takeover with another business

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Takeover (acquisition)

When one business buys out the owners of another business

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Merger (external growth)

When the owners of 2 businesses agree to join their firms together to make one business

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Horizontal merger (integration)

When firm merges / takes over another one in the:

  • Same industry at the same stage of production (sector)

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Vertical merger (Vertical integration)

Same industry but at different stages of production

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Forward vertical integration

Same industry but at a later stage of production (closer to the consumer)

  • Manufacturing → retail

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Backward vertical integration

Same industry but at a earlier stage of production (closer to the raw material )

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Conglomerate merger (integration)

Different industry

  • Known as diversification

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Benefits of a horizontal integration

(3 points)

  • Merger: Reduced number of competitors in the industry

  • More opportunities for economies of scale

  • The combined businesses will have a bigger market share

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Benefits of a vertical integration

(4 points)

You get more control over the distribution of goods and services

  • Merger: 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

    • BV: Supplier, supplying other manufacturers

  • Information about consumer needs obtained directly from the manufacturer

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Benefits of a conglomerate integration

(2 points)

  • Diversified its activities: the risks taken by the firm are spread

  • Expanded customer base

  • Transfer of ideas between the different sections of the business → helps improve the quality + demand for both products

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Problems resulting from business expansion

(4 points)

  1. A larger business is difficult to control (diseconomies of scale)

  2. Larger business → poor communication

  3. Expensive expansion costs → business is short of finance

  4. Integrating with another business can be difficult → due to different management styles

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How would you overcome the issue ‘a large business is difficult to control’ due to expansion?

Operate the business in smaller parts

  • Form of decentralisation

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How would you overcome the issue ‘a large business has poor communication‘ due to expansion?

  1. Operate the business in smaller units

  2. Use technology to communicate (emails)

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How would you overcome the issue ‘a firm is short of finance‘ due to expansion costing so much?

  1. Expand slower + use the profits from the slowly expanding business to pay for further growth

  2. Ensure sufficient long-term finance is available

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How would you overcome the issue ‘integrating with another business is more difficult than expected‘ due to expansion

Introduce a different style of management

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Why do some businesses remain small?

(3 points)

  1. The type of industry the business operates in

  2. The market size

  3. The owners’ objectives

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Why do businesses remain small due to the type of industry they operate in?

  • Businesses that offer personalised services/products → grow too large → difficult to offer the close and personal services demanded by the customers

  • In these industries, it is easy to set up new businesses → creates new competition

    • Hairdressers, car repairs, and catering

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Why do businesses remain small due to the market size?

  • Total number of customers is small like in rural areas → no need for it to expand

  • These businesses produce specialised products that appeal to a limited number of consumers

    • Luxurious cars, expensive clothing, shops in rural areas

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Why do businesses remain small due to the owners’ objectives?

Some owners want to:

  • Keep control of a small business

  • Have personal contact with staff and customers

    • To avoid the stress of running a large firm

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Causes of business failure

(4 points)

  1. Lack of management skills

  2. Changes in the business environment

  3. Liquidity problems/poor financial management

  4. Over-expansion

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How does having a lack of management skills lead to business failure?

  • Lack of experiencebad decisions

    • Locating the business in an area with high costs but low demand

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How do changes in the business environment lead to business failure?

(2 points)

  • Failure to plan for change adds to the risks of operating a business

  • Firms must be ready to change their products to meet the demands of customers (failure to do so leads to customer loss)

    • External shocks (economic change, legal + social change), new technology, + new competitors cause failure if they are not responded to effectively

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How does poor financial management lead to business failure?

  • Failure to forecast cash flows cause a shortage of cash (lack of liquidity)

    • Workers, suppliers, landlords, + the government cannot be paid what they are owed

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How does over-expansion lead to business failure?

  • Business expands too quickly (over its optimum level) → major management and financial problems

  • Causes diseconomies of scale

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Reasons specifically for why new businesses fail

(4 points)

  1. It is difficult to test a business model without trading

  2. Easy to be over-optimistic in the business plan

  3. Competitor response is aggressive

  4. Management may lack experience

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Why are new businesses at a greater risk of failing than well-established ones?

(3 points)

  • Lack of finance and other resources

  • Poor planning and inadequate research

  • They lack the experience and decision-making skills of managers who work for larger businesses

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