CHAPTER 2

TYPES OF BUSINESS ACTIVITY

Levels of economic activity

In order for products to be made and sold to the people, it must undergo 3 different production processes. Each process is done by a different business sector and they are:

·         Primary sector: The natural resources extraction sector. E.g. farming, forestry, mining... (earns the least money)

·         Secondary sector: The manufacturing sector. E.g. construction, car manufacturing, baking... (earns a medium amount of money)

·         Tertiary sector: The service sector. E.g. banks, transport, insurance...(earns the most money)

·         Importance of a sector in a country:

·         Number of workers employed.

·         Value of output and sales.

Industrialization: a country is moving from the primary sector to the secondary sector.

De-industrialization: a country is moving from the secondary sector to the tertiary sector.

In both cases, these processes both earn the country more revenue.

Types of economies

Free market economy:

All businesses are owned by the private sector. No government intervention.

Pros:

·         Consumers have a lot of choice

·         High motivation for workers

·         Competition keeps prices low

·         Incentive for other businesses to set up and make profits

Cons:

·         Not all products will be available for everybody, especially the poor

·         No government intervention means uncontrollable economic booms or recessions

·         Monopolies could be set up limiting consumer choice and exploiting them

Command/Planned economy:

All businesses are owned by the public sector. Total government intervention. Fixed wages for everyone. Private property is not allowed.

Pros:

·         Eliminates any waste from competition between businesses (e.g. advertising the same product)

·         Employment for everybody

·         All needs are met (although no luxury goods)

Cons:

·         Little motivation for workers

·         The government might produce things people don't want to buy

·         Low incentive for firms (no profit) leads to low efficiency

Mixed economy:

Businesses belong to both the private and public sector. Government controls part of the economy.

Industries under government ownership:

·         health

·         education

·         defense

·         public transport

·         water & electricity

Privatization

Privatization involves the government selling national businesses to the private sector to increase output and efficiency.

Pros:

·         New incentive (profit) encourages the business to be more efficient

·         Competition lowers prices

·         Individuals have more capital than the government

·         Business decisions are for efficiency, not government popularity

·         Privatization raises money for the government

Cons:

·         Essential businesses making losses will be closed

·         Workers could be made redundant for the sake of profit

·         Businesses could become monopolies, leading to higher price

Comparing the size of businesses

Businesses vary in size, and there are some ways to measure them. For some people, this information could be very useful:

·         Investors - how safe it is to invest in businesses

·         Government - tax

·         Competitors - compare their firm with other firms

·         Workers - job security, how many people they will be working with

·         Banks - can they get a loan back from a business?

Ways of measuring the size of a business:

·         Number of employees. Does not work on capital intensive firms that use machinery.

·         Value of output. Does not take into account people employed. Does not take into account sales revenue.

·         Value of sales. Does not take into account people employed.

·         Capital employed. Does not work on labor intensive firms. High capital but low output means low efficiency.

You cannot measure a business size by its profit, because profit depends on too many factors not just the size of the firm.

Business Growth

All owners want their businesses to expand. They reap these benefits:

·         Higher profits

·         More status, power and salary for managers

·         Low average costs (economies of scale)

·         Higher market share

Types of expansion:

·         Internal Growth: Organic growth. Growth paid for by owner’s capital or retained profits.

·         External Growth: Growth by taking over or merging with another business.

Types of Mergers (and main benefits):

a.    Horizontal Merger: merging with a business in the same business sector.

·         Reduces no. of competitors in industry

·         Economies of scale

·         Increase market share

b.    Vertical merger:

1. Forward vertical merger:

·         Assured outlet for products

·         Profit made by retailer is absorbed by manufacturer

·         Prevent retailer from selling products of other businesses

·         Market research on customers transferred directly to the manufacturer

2. Backward vertical merger:

·         Constant supply of raw materials

·         Profit from primary sector business is absorbed by manufacturer

·         Prevent supplier from supplying other businesses

·         Controlled cost of raw materials

c.    Conglomerate merger:

·         Spreads risks

·         Transfer of new ideas from one section of the business to another

Why some businesses stay small:

There are some reasons why some businesses stay small. They are:

·         Type of industry the business is in: Industries offering personal service or specialized products. They cannot grow bigger because they will lose the personal service demanded by customers. E.g. hairdressers, cleaning, convenience store, etc.

·         Market size: If the size of the market a business is selling to be too small, the business cannot expand. E.g. luxury cars (Lamborghini), expensive fashion clothing, etc.

·         Owner’s objectives: Owners might want to keep a personal touch with staff and customers. They do not want the increased stress and worry of running a bigger business.