Resources used in the production of goods and services
Economics is the study of using resources to produce goods and services as effectively and efficiently as possible to satisfy the needs and wants of consumers. In agriculture, the producer of goods or services may be an agribusiness firm manufacturing a food product that meets the desires of consumers, or agricultural producers growing a crop to meet the needs of a food processor. To produce a product (a good or service), a business needs resources, such as labor (i.e., workers), land (e.g., a building), equipment, cash (capital) and other resources. Restated: to operate a business, the manager needs resources, and one of the manager's responsibilities is to decide which resources to use and how to use them. Show
Our economic system is based on the idea that the individual who provides the economic resource is entitled to be compensated. This page reviews how economic theory describes resources needed to produce a product. The page also introduces an alternative description that is followed throughout these materials. A case study provides an example that illustrates an application of the alternative description. Additional topics on this page are intended to illustrate several applications of our understanding of economic resources. The discussion on this page assumes the reader has previously been introduced to the concepts of economic resources, opportunity cost, balance sheet, income statement, return on assets and return on equity. . Economic Theory (Traditional) DescriptionEconomic resources used in the production of goods and services can be categorized as
. The respective returns to these resources is often described as
That is, the owner of land is entitled to receive rent, the worker is entitled to receive a wage, the owner of capital is entitled to an interest payment, and the entrepreneur retains any profit.
The challenge for a business manager is to decide how to use these economic resources to profitably produce a good or service. Reminder: profit can be explained as 'using economic resources to produce a product that will generate revenue that is greater than the cost of the resources being used'. . Alternative Description of Economic ResourcesWould it be helpful to categorize the economic resources and their returns as land (rent), labor (wage), capital (interest), information (royalty), business reputation (goodwill) and assuming the risk of a net operating loss (profit)? Restated, is there an alternative description for economic resources? How about:
This materials challenge and encourage students to refine their thinking about economic resources; recognize six categories of economic resources, rather than the traditional four categories; and to consider whether six categories can help managers clarify their decision making process. . The respective returns to these resources would be
. Table 1. Traditional and Alternative Descriptions of Economic Resources and Their Respective Returns Traditional Description Return Alternative Description Return LandRentLandRentLaborWageLaborWageCapitalInterestCapitalInterestEntrepreneurial abilityProfitInformationRoyaltyBusiness ReputationGoodwillRiskProfit. The primary differences between the two descriptions of economic resources are
Precision agriculture is upon agricultural producers, for example. Producers are using global positioning technology (GPS) to identify locations, sensors to monitor growing crops and livestock, and field equipment to apply seed, fertilizer and pesticides at variable rates. Each of these technologies relate to information. Access to such data and application of such information in deciding how to grow agricultural commodities throughout the season illustrate that the information age is truly upon us. Accordingly, our explanation of economic resources needs to be refined to reflect these changes in the agriculture industry. Similar statements can be made about changes in consumer tastes and preferences for agricultural-based products. Information about consumer demand, about technology to produce products that align with such demand, and about delivering the products to the consumers also are components of the information age. Computer technology does not define the information age; computer technology is merely a significant tool for the information age. . Additional thoughts about the resource categories:
. A comment from Saxowsky: as a child decades ago, I remember my Dad making reference to my maternal grandfather (who died when I was a toddler) by posing these questions: Can business owners borrow themselves rich? How would you answer these questions and how would you explain your answers? A colleague observed that the alternative description of economic resources can be described as "more thoroughly explaining entrepreneurial ability." . Applying the Concept of Six Economic ResourcesCan you think of examples where this alternative description of economic resources may impact your analysis of a situation?
To what extent can each of these resources be "purchased" if the business owner does not already possess them? To what extent does the business owner have to bring these resources to the enterprise, rather than rely on someone else to provide them? What is the impact of the business owner "purchasing" the resources, rather than "bringing them" to the business? . . Additional Applications of the Concept of Economic ResourcesReminder: a person who owns an economic resource is entitled to be compensated by the business that uses the economic resource. Likewise, a person who owns an economic resource and uses it in his or her own business is entitled to be compensated for the use of that resource, that is, the business should return enough to the resource/business owner to compensate for using that resource in their own business. This expectation is discussed in more detail as part of Accounting Profit and Opportunity Cost. . The following table represents the categories of resources used in a business. . Table 2. Owner's ResourcesResources belonging to Someone ElseLand that is owned by the business owner and used by the owner in the businessLand owned by another person but leased by the business owner so it can be used in the businessThe time the owner works in the business; that is the business owner's labor used in the business (this category includes the owner's management)The labor the owner hires from othersThe owner's capital that owner uses in the business (equity capital); this category includes investorsThe capital the owner borrowers from a lender; this category also includes unpaid creditors such as an input supplier, laborer, or landowner who has not yet been paid (debt capital)The information the owner has that the owner uses in the business, e.g., marketing and production insightsThe information the business owner buys from its owner, this category includes technology that is incorporated into equipment or other inputs the owner purchases from othersThe reputation and relationships with suppliers, customers, lenders, investors and others who interact with the businessThe relationships maintained by others that the business owner negotiates to participate inThe risk the owner accepts by owning and operating the business; this category includes investors who have committed to providing additional capital in the future if and when additional capital is neededThe risk that others accept in the business, e.g., an insurance company that is paid a premium. Relationship Between Economic Resources and Financial StatementsFinancial statements (e.g., balance sheet and income statement) are discussed in more detail on other pages, but it may be helpful to briefly introduce the relationship between the categories of economic resources and these basic financial statements. . Balance SheetThe following table is an example of a simple balance sheet. It lists the business assets, liabilities and the calculates the owners' equity in the business; these are the three basic components of a balance sheet. Remember that a balance sheet presents the information about asset values and amounts owed "as of a specific date." . Table 3. Assets Land $1,700,000 Value of land owned by the business 900,000 Value of equipment owned by the business 320,000 Value of product inventory owned by the business 214,000 Amount of cash the business has on hand Total Assets $3,134,000 Liabilities $325,000 Debt owed to Lender 1 416,000 Debt owed to Lender 2 117,000 Debt owed to Lender 3 Total Liabilities $858,000 Equity $2,276,000 Value of the business from the owners’ perspective . Note however, the business resources that are not listed on the balance sheet, such as the value of the owners' labor, the value of employee labor, the value of leased land, and the value of leased equipment. Accordingly, a balance sheet does not provide a complete inventory of the business' economic resources from a manager's perspective. Subsequent discussion considers the importance of a manager recognizing these other economic resources when reviewing and using the information provided by a balance sheet. . HINT -- the information on a balance sheet may be more valuable/useful to the business lenders than it is to the business manager. . The following table restates the preceding information by indicating categories of economic resources that are summarized on the business' balance sheet. Nine cells in this table (that is, nine categories of economic resources) are not represented on a business' balance sheet. A business balance sheet does not report all the economic resources used in operating a business. . Table 4. Categories of a Balance Sheet in which Business Resources are Summarized. Resource Owner's ResourceSomeone Else's ResourceLandListed on the Balance Sheet as an asset (also contributes to the owner's equity)Not listed on the balance sheetLaborOwner's labor is not listed on the balance sheetEmployees' labor is not listed on the balance sheet.CapitalListed on the Balance Sheet as an asset (also contributes to the owner's equity)Listed on the Balance Sheet as a liability (but the loan proceeds also are listed as an asset, such as capital or the items purchased with the loan proceeds)InformationMost likely is not listed on the balance sheet.Not listed on the balance sheetBusiness ReputationNot listed on the balance sheetNot listed on the balance sheetRiskNot listed on the balance sheetNot listed on the balance sheet. Income StatementA similar description can be offered for the income statement. The following table provides a simple example of an income statement. Remember, an income statement reports "the value of product produced by a business during a specified time period (such as a year or a quarter) and the cost of the inputs used to produce that product during that time period." These definitions are discussed more fully on other pages. . Table 5. Sample Income Statement Illustrating Costs Associated with Categories of Economic Resources Revenue $950,000 Buyers compensating the business owners for the product the business owners provided; it may be more precise to state that revenue is the value of the product produced during this time period Costs 80,000 Compensates owner of the leased land 110,00 Compensates the laborer 25,000 Compensates the lender 140,000 Need to discuss this concept in another section 3,500 Compensates the market information provider 38,000 Compensates the risk taker
432,000 Compensates others for the production inputs they provided to the business Total Cost $825,500 Net Earnings or Profit $124,500 Compensates the business owners for their land, labor, capital, information, business reputation, and risk exposure; the cost of compensating the business owners for the assets they contribute to the business is not explicitly listed on the income statement . Return on Assets and EquityBusiness people often measure the financial progress of a business by calculating and assessing the business' 1) Return on Assets (ROA) and 2) Return on Equity (ROE). The following table indicates which cells represent the returns reported on an income statement. Note, the business' net income is represented by the Owner's Return column. Recall that the three basic components of an income statement are revenue, cost, and net income. Restated, a firm's income is reported as revenue on the income statement; the portion of the income that is paid to others is a cost. The portion of the revenue that is available to compensate the business owners' for their assets is the Net Income (as calculated with the use of an income statement). . Table 6. Components of Income Statement Where Compensation for Economic Resources are Reported Return to . The following table indicates which cells are included in the owner's return to asset (ROA). The return to the business' assets is represented as net income minus an opportunity cost for the owner's labor plus the interest paid to others. It is not clear whether an opportunity cost has been subtracted for the owner's information, business reputation and risk (it depends on your definition of assets). If the definition of assets is "tangible assets that a lender can seize", an opportunity cost for the owners' information, business reputation and risk (that is, intangible assets) must be subtracted to calculate return on assets. If the definition of assets is "everything the owners contribute to the business except their labor", an opportunity cost for owners' information, business reputation, and risk is NOT subtracted when calculating the return on assets. . Table 7. Economic Resources Whose Compensation is Included in Calculating ROA Return to (added interest cost to accounting profit) Royalty (information)Business Reputation (goodwill)Profit (risk). Note the similarities between tables 4 and 7. . Table 8. Example of Calculating Return on Assets Net earnings or profit $124,500 From table 5 Value (opportunity cost) of owner’s labor - $43,000 Based on owner’s own assessment Amount of interest paid to lenders + 25,000 From table 5 Return on Assets (stated as a dollar amount) $106,500 In this example, an opportunity cost for the owners' information, business reputation, and risk is NOT subtracted; therefore, the return on assets is for ALL owners' assets except labor. . The following table indicates which cells are included in the owner's return to equity (ROE). The return to the owner's equity is represented as net income minus an opportunity cost for the owner's labor. It is not clear whether an opportunity cost has been subtracted for the owner's information, business reputation, and risk. Table 9. Categories of Economic Resources Whose Compensation is included in Calculating ROE Return to subtracted an opportunity cost. Interest (capital)Royalty (information)Business reputation (goodwill)Profit (risk). Table 10. Example of Calculating Return on Equity Net earnings or profit $124,500 From table 5 Value (opportunity cost) of owner’s labor - $43,000 Based on owner’s own assessment Return on Equity stated as a dollar amount $81,5000 The same discussion about opportunity cost for the owners' information, business reputation, and risk applies to this example of Return on Equity. . Closing Thoughts The process of calculating ROA and ROE is consistent with the preparation of a balance sheet and calculating asset values and equity; that is, the value of the owner's land and capital are included in the business balance sheet, but not the owner's labor. The amount of borrowed capital is incorporated into the assets on a balance sheet, thus the interest cost of the borrowed capital is added back into the business net returns when calculating ROA. The interest cost is NOT added back when calculating ROE. Business owners are entitled to be compensated for their labor so an opportunity cost of their labor is subtracted from the business' net income when calculating ROA or ROE. ROA and ROE are not only the return to the business owner's land and capital, but as the return to the business owner's risk exposure, information and business reputation, for which not opportunity cost has been subtracted. . In analyzing business profit, the owner needs to identify which resources the owner is contributing, the owner's opportunity cost for contributing those resources to the business, and whether the business' net income adequately compensates for all of those opportunity costs. . Case Study (by Dr. Cole Gustafson, NDSU).
. Who provided each of the economic resources in this farm operation?
HINT: Review table 2. Review Dr. Gustafson's description of this farm business. Can you place the facts into the 12 categories presented in table 2? Can you now answer the questions? . Summary The person who contributes or provides an economic resource is entitled to be compensated. It may be helpful to identify who is contributing which resources to a business venture and then determine the appropriate compensation for that contribution. A challenge, however, can be identifying who is making the contribution, e.g., who is providing the market and production information, who is assuming the risk(s), who is providing the capital? This challenge is further complicated because these economic resources can take on various forms. The bulk of business financial analysis focuses on several assets: land and capital (such as inventory, equipment, and cash). But managers need to consider all six economic resources: how to manage labor, how to manage risk, information and business reputation. Business management is more than the cash, land and other assets that lenders might emphasize. Even lenders and investors need to think about how a business employs and how a manager controls and uses all economic resources needed to operate the business. Managers must not narrow their focus on those components of the business that are measured on a balance sheet or in financial ratios. Managers must think about and oversee each of the resources needed in the business: land, labor, capital, information, risk exposure and business reputation. . The next topic suggests that management is decision making; such as, deciding how a business uses these economic resources to produce a product. What are the three resources needed to produce any good and service?The factors of production in an economy are its labor, capital, and natural resources. Labor is the human effort that can be applied to the production of goods and services. People who are employed or would like to be are considered part of the labor available to the economy.
What are examples of production resources?There are three basic productive resources: natural resources, human resources, and capital resources. Natural resources are things such as minerals, water, trees, and land itself. Several types of natural resources are used to make a pair of jeans. It takes land to grow cotton.
What are production goods and services?Production Goods and Services means goods and services including (a) production and service parts, components, assemblies and accessories, (b) raw materials, (c) tooling and (d) design, engineering or other services.
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