Why business activity exists
People have unlimited wants but the world has only limited resources. This mismatch is called scarcity. Business activity uses the four factors of production to turn scarce resources into goods and services that satisfy those wants. When a business combines land, labour, capital and enterprise well, it adds value so the selling price is higher than the cost of the inputs.
Key idea
Scarcity forces every person, business and government to make choices. Choosing one option always means giving up another.
Opportunity cost
Because resources are scarce, choosing to use them one way means missing out on the next best use. The opportunity cost is the next best alternative that is given up when a choice is made. A firm that spends money on new machinery cannot also spend that same money on a marketing campaign; the campaign is the opportunity cost.
Example
A baker has enough flour to make either 200 loaves of bread or 150 cakes. If the baker chooses to make the bread, the opportunity cost is the 150 cakes that could have been made instead.
Adding value
Adding value means increasing the difference between the cost of inputs and the price customers will pay. A cafe adds value by turning cheap coffee beans into a served drink. Firms add value through branding, good design, convenience and quality so customers are willing to pay more.
Remember
- Scarcity means limited resources, unlimited wants.
- Opportunity cost is the next best alternative given up.
- Factors of production: land, labour, capital, enterprise.