S10

IGCSE®/O Level Economics

4.2 Organization of production

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 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)

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 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

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 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

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 Aims of production

Most private sector firms aim to maximize profit

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.

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
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 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.

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 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.

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 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

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 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 • Carrying out the same task

employee’s abilities again and again may become
• It reduces time spent by boring
employees changing tasks • Workers may lack pride in
• It allows greater use of their work because they do
machinery not see the final result of their
efforts
• It increases output
• Products become too
standardized through mass
production

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 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
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 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

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 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

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 The costs of production (activity 4.12)
Magazines Total Total Total Average Total Profit or
per month fixed variable cost cost Revenue Loss
costs costs

0 $4,000 0 $4,000 - 0 - $4,000

1,000 $4,000 $3,000 $7,000 $7.00 $5,000 -$2,000
2,000 $4,000 $6,000 $10,000 $5.00 $10,000 0
3,000 $4,000 $9,000 $13,000 $4.33 $15,000 $2,000
4,000 $4,000 $12,000 $16,000 $4.00 $20,000 $4,000
5,000 $4,000 $15,000 $19,000 $3.80 $25,000 $6,000
6,000 $4,000 $18,000 $22,000 $3.67 $30,000 $8,000
7,000 $4,000 $21,000 $25,000 $3.57 $35,000 $10,000
8,000 $4,000 $24,000 $28,000 $3.50 $40,000 $12,000

• 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

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 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

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 How to make it easier to break-even

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