concept of opportunity cost

1.1 Business Activity – Needs, Wants, Scarcity and Opportunity Cost

Needs vs. Wants

• Need: A basic requirement for survival or for a business to operate (e.g., raw material, electricity, skilled staff).
• Want: Anything that is desired but not essential (e.g., a designer logo, a premium coffee machine in the staff kitchen).
• Businesses allocate scarce resources to needs first; wants are considered only after needs are met.

Scarcity

• Resources (time, money, raw materials, labour, technology) are limited while wants are unlimited.
• Scarcity forces managers to make choices – every decision involves giving up something else.
• Note for exam: In developing economies the primary sector is relatively larger, whereas in developed economies the tertiary sector dominates.

Opportunity Cost

Opportunity cost is the value of the next‑best alternative that is foregone when a decision is taken. It reflects the sacrifice of the most valuable option that is not chosen.

Why it matters for business

• Shows the true cost of a decision – not just the cash outlay.
• Ensures scarce resources are used efficiently.
• Provides a basis for comparing alternatives in strategic planning.
• Underpins profit‑maximisation, cost‑benefit analysis and risk assessment.

Formula (knowledge only – not examined)

Opportunity Cost = Benefit of the best forgone alternative

Worked Example – Bakery

1. Option 1: Bake 100 loaves of bread – profit £300.
2. Option 2: Bake 60 cakes – profit £360.

If the bakery chooses to bake bread, the opportunity cost is the profit it could have earned from the cakes:

Opportunity Cost = £360 – £300 = £60

Worked Example – School Funding

A school has £10 000 to spend on either:

• Sports equipment – expected benefit £12 000.
• Arts programme – expected benefit £13 500.

Choosing the sports equipment means the opportunity cost is the foregone benefit of the arts programme (£13 500).

Exam‑style AO1 Question (Identify the Opportunity Cost)

Scenario: A small retailer can use a £5 000 marketing budget to either run a social‑media campaign (expected profit increase £2 200) or redesign its shop window (expected profit increase £2 800). The retailer chooses the social‑media campaign. Identify the opportunity cost.

Opportunity‑Cost Comparison Table

Key Points to Remember

• Opportunity cost is a decision‑making tool; it does not appear in financial statements.
• It always refers to the next‑best alternative, not to every possible alternative.
• Both explicit costs (cash outlays) and implicit costs (foregone benefits) are considered.
• Understanding opportunity cost helps businesses allocate scarce resources effectively and justify choices to stakeholders.

1.2 Classification of Businesses

Primary, Secondary and Tertiary Sectors

Changing importance of sectors

• In developing economies the primary sector contributes a larger share of GDP and employment.
• In developed economies the tertiary sector dominates, reflecting higher consumer demand for services.

Private vs. Public Ownership

• Private sector: Owned by individuals or groups of investors; profit‑oriented (e.g., a family‑run bakery).
• Public sector: Owned and operated by the government; aims to provide services rather than profit (e.g., public hospitals, state‑run utilities, public corporations).

Case‑Study Excerpt (Data‑Response Stimulus)

Company A – Mining Ltd (Primary, Private)

• Extracts copper in a developing country.
• Exports 80% of output, generating £45 million in revenue.
• Faces environmental regulations and community pressure.

Company B – RetailCo (Tertiary, Private)

• Operates a chain of clothing stores in a developed economy.
• Annual turnover £120 million.
• Focuses on fast fashion and online sales.

Students may be asked to compare the two firms in terms of sector, ownership, and typical challenges (AO3).

1.3 Enterprise & Business Growth

Entrepreneurship

• Identifies a market need, takes risk, and creates a new business.
• Key characteristics: innovation, willingness to take calculated risk, determination, ability to organise resources.

Simple Business Plan Outline

1. Executive summary
2. Business description and objectives
3. Market analysis
4. Organisation & management
5. Products / services
6. Marketing & sales strategy
7. Financial projections (start‑up costs, cash‑flow forecast, break‑even analysis)

Measuring Size & Growth

Ways Businesses Can Grow

Growth‑Path Flowchart (visual aid)

Start → Identify Growth Objective
      ↓
Choose Growth Type
   ├─ Organic → Invest in R&D / New facilities → Increase output
   └─ Inorganic → Search for partner / Target acquisition → Merge or acquire → Expand market reach
      ↓
Monitor performance (sales, profit, market share)

Common Causes of Business Failure

• Inadequate finance (insufficient start‑up capital or cash flow problems).
• Poor market research – product does not meet consumer needs.
• Weak management – lack of planning, poor delegation.
• Ignoring opportunity costs – allocating resources to low‑return activities.
• External shocks (economic recession, legal changes).

1.4 Types of Business Organisation

Evaluation Prompt (AO4)

“Assess which organisational form would be most suitable for a start‑up that wants rapid expansion but wishes to retain tight control over product quality.”

1.5 Business & Stakeholder Objectives

Typical Business Objectives

• Survival (stay in operation)
• Profit maximisation
• Growth (increase market share, expand output)
• Market leadership
• Social or environmental responsibility (CSR)

Stakeholder‑Objective Matrix

Conflict Illustration (Profit vs. Environment)

A manufacturing firm can increase profit by extending its operating hours, but this would raise carbon emissions and upset local residents. Students should analyse how the firm might balance profit‑maximisation with environmental objectives (e.g., investing in cleaner technology).

Private‑Sector vs. Public‑Sector Objectives

• Private‑sector: Primarily profit‑oriented; growth and market share are key performance indicators.
• Public‑sector: Focus on service delivery, equity, and social welfare; profit is not a performance measure, though efficiency remains important.

Assessment Objectives (AO1 – AO4)

• AO1 – Knowledge: Define key terms (needs, wants, scarcity, opportunity cost, etc.) and recall facts about business structures.
• AO2 – Understanding: Explain why opportunity cost influences decision‑making; describe how different organisations operate.
• AO3 – Application/Analysis: Use a decision‑tree or table to calculate opportunity cost in a given scenario; compare two forms of business organisation.
• AO4 – Evaluation: Justify a business choice by weighing opportunity costs against other objectives; assess the impact of a chosen organisational form on risk and profit.

Practice Questions (Covering AO1‑AO4)

1. AO1: Define “scarcity” and give one example of a scarce resource for a small retailer.
2. AO2: Explain why a business must consider both explicit and implicit costs when calculating opportunity cost.
3. AO3: A clothing manufacturer can use a fabric stock to produce either 500 T‑shirts (profit £7 500) or 300 jackets (profit £9 000). Using a table, show the opportunity cost of producing the T‑shirts.
4. AO4: A start‑up is deciding between operating as a sole trader or forming a private limited company. Evaluate the advantages and disadvantages of each form in relation to risk, finance and control, and recommend the most suitable form for a business that plans rapid expansion.
5. AO4 (Opportunity‑cost focus): A café has £4 000 to spend on either a new espresso machine (expected profit increase £2 200) or a patio extension (expected profit increase £2 800). The owner chooses the espresso machine. Analyse the decision, calculate the opportunity cost, and discuss two non‑financial factors that might justify the chosen option.
6. AO3 (Data‑response – case study): Using the case‑study excerpt on Mining Ltd and RetailCo, compare the two firms in terms of sector, ownership, typical challenges and the relevance of opportunity cost to their decision‑making.

Suggested Diagrams

• Decision‑tree showing two alternatives, their respective profits, and the calculation of opportunity cost.
• Stakeholder‑objective matrix (provided above).
• Business‑organisation comparison chart with risk & control column (provided above).
• Growth‑path flowchart (organic vs. inorganic growth).

Syllabus Mapping – Section 1 (Business Activity)

Next Steps – Sections 2‑6

Use the same structure for the remaining syllabus sections (People, Marketing, Operations, Finance, External Influences). Each section should contain:

1. A clear definition of key concepts.
2. Real‑world examples and, where appropriate, simple calculations.
3. Tables or diagrams that summarise information.
4. Practice questions that address all four assessment objectives.