IGCSE®/O Level Economics 4.2 Organization of production

Production Goods and services are produced to satisfy consumers’ needs and wants The production of goods and services is organized by entrepreneurs in firms A firm combines land, labour and capital (inputs) to make goods and services (outputs)

Production adds value to resources Production adds value to resources by turning them into goods and services consumers want and are able to buy. Value added: the difference between the market price paid for a product by a consumer and the cost of the natural and man-made materials, components and resources used to make it Value added = profit + wages

Industrial sectors An industrial sector or industry is a group of firms specializing in similar goods and services, or using similar production processes Primary sector The extraction and production of natural resources Secondary sector Construction and manufacturing Manufacturing: turning unprocessed natural resources and other unfinished products into other goods Tertiary sector Personal and business services

Aims of production Most private sector firms aim to maximize profit These are examples of other types of organization: Charities aim to help people or animals in need, or to protect the natural environment. They rely on donations or gifts of money to cover their costs Not-for-profit organizations, such as cooperatives and local sports and social clubs, are run for the benefit of their members. Any surplus of revenue over costs is used to reinvest in the organization or to lower prices Public sector organizations provide public services, e.g. public health services, education Profit is a surplus of revenue over costs. It is reward for enterprise and risk taking. Without it people would not start up and own business organizations.

Productivity Productivity measures the amount of output (goods and services) that can be produced from a given amount of input (land, labour and capital resources). Productive More productive The aim of any business will be to combine its resources in the most efficient way: to produce as much output as it can with the least amount of resources it can, and therefore at the lowest cost possible.

Labour productivity Labour productivity is the most commonly used measure of factor productivity. It can be measured by the average amount of output each employee produces per period of time, or by the average amount of revenue each employee contributes per period of time, as a result of his or her efforts.

Improving productivity Same amount of inputs, same costs but more output = lower average cost per unit Strategies to increase productivity include: training employees to improve their skills rewarding increased productivity with performance-related pay increasing job satisfaction replacing old equipment and machinery with new technologies introducing new production processes to reduce waste, improve quality and speed up production the division of labour factor substitution

The division of labour Increased labour productivity over time has been the result of the division of labour: each worker specializes in one particular task or operation in a production process Advantages Disadvantages It makes best use of an employee’s abilities It reduces time spent by employees changing tasks It allows greater use of machinery It increases output Carrying out the same task again and again may become boring Workers may lack pride in their work because they do not see the final result of their efforts Products become too standardized through mass production

Capital or labour intensity in production? Labour-intensive production Capital-intensive production The relative demand for labour and capital by a firm will depend on: how much output consumers demand the cost of labour relative to the cost of employing capital the productivity of labour relative to capital

Factor substitution Factor substitution is the substitution of capital for labour in production processes as: the productivity of capital equipment increases relative to labour the cost of capital falls relative to wage costs But: machines cannot replicate the work of a doctor, solicitor, hairdresser or other workers providing personalized care and services some firms cannot afford to install and maintain new machinery some consumers want personalized not mass-produced products

The costs of production Fixed costs do not vary with output, e.g. rent, insurance premiums, loan repayments Variable costs vary directly with output, e.g. cost of materials, performance-related pay Total variable cost: variable cost per unit x number of units Total cost: total fixed cost + total variable cost

The costs of production (activity 4.12) The average cost of each unit of a good or service will tend to fall as output rises because total fixed costs are spread over a much larger output But, after a point, average costs may start to rise again if it becomes more difficult and expensive to increase output

Profit, loss or break-even? Profit = total revenue – total cost Break-even level of output : total revenue = total cost or total revenue – total cost = 0

How to make it easier to break-even