What provide the resources needed by the company to produce its goods and services?

Business management involves making decisions about how to use resources to produce a product or service. This page introduces five general economic resources.

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.

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.

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Economic Theory (Traditional) Description

Economic resources used in the production of goods and services can be categorized as

• Land (all natural resources),
• Labor (all physical and mental talents of individuals),
• Capital (all manufactured aids/tools/equipment used in producing goods and services, and cash), and
• Entrepreneurial ability (the initiator, innovator, strategic decision maker, risk taker, the relationship builder; restated, the person with the willingness and ability to initiate a business, innovate new ideas, bear the risk of owning a business, and establish business relationships with suppliers, customers, lenders, investors, and others).

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The respective returns to these resources is often described as

• rent for land;
• wages for labor;
• interest for capital; and
• profit for the entrepreneur.

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.

Based on Economic Resources (and their return), McConnell and Brue. Economics 16th ed. Boston: McGraw-Hill Irwin. 2005.

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'.

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Alternative Description of Economic Resources

Would 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:

• land (natural resources),
• labor (physical and mental talents of individuals, including management skills),
• capital (cash and manufactured items [e.g., tools and equipment] used to produce other products),
• information and innovation (assembling information about market opportunities [both buying and selling] and creating production technologies),
• business reputation (industry network, member of industry's supply chain, business ethics), and
• accepting or bearing the risk of business ownership (i.e., a willingness and ability to bear the risk of owning and controlling a business that may incur a net operating loss).

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.

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The respective returns to these resources would be

• rent for land;
• wages for labor (including management);
• interest for capital;
• royalty for information;
• goodwill for business reputation; and
• profit for bearing the risk of business ownership.

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Table 1.  Traditional and Alternative Descriptions of

Economic Resources and Their Respective Returns

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The primary differences between the two descriptions of economic resources are

• being a manager does not entitle an individual to the profit; a person must accept and bear the risk that the business may incur a net operating loss to be entitled to the profit;
• market information and production technology are economic resources that can be bought, sold and controlled;
• persons who have information are entitled to be compensated for their information; and
• there is a need for business relationships and a business reputation, and there is value (be it a fragile value) in having a positive business reputation.

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.

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Additional thoughts about the resource categories:

• Management is a type of labor and managers are entitled only to a wage (not profit).
• Business owners can own each of these resources and use them in their own business, or a business owner can acquire each of these resources from another person and then use the resources in the business, such as hiring an employee, renting land or borrowing capital. For example:
  
  • Capital is a combination of debt and equity capital.
  • Land is a combination of owned and leased land.
  • Labor is a combination of the owners' effort and employees' efforts.
• Information encompasses production technology and market information.
  • Market information includes information about both input and product markets; for example, where can an input be acquired and at what cost; or, where can a business find buyers for its product and what price are the buyers willing to pay for the business' product.
  • Information can be 1) public, 2) private but available for purchase, or 3) private and unavailable; the implications of these three categories of information are discussed throughout these materials.
• Some resources do not fit neatly into just one category, for example, is it labor when a person knows how to produce a product (that is, a skill of the owner or an employee that is compensated with a wage) or is that knowledge/insight a type of information?
• Risk is a combination of 1) an ability or capacity to bear risk and 2) a willingness to bear risk; both are needed to assume or bear risk.  This combination (ability and willingness) is discussed throughout these materials.
  • A business can pay someone to assume risk, e.g., insurance; but risk also is altered or managed when the business owner pays extra for an input to assure the input is always available for the business operation, e.g., a farmer contracts that the feed supplier provides a delivery each Wednesday morning.
  • A challenge for a business decision maker is to recognize that "if business owners pay for all risks to be assumed by someone else, no profit will remain for themselves".

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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? 
Can business owners insure themselves poor?

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."

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Applying the Concept of Six Economic Resources

Can you think of examples where this alternative description of economic resources may impact your analysis of a situation?

• What might be the implications of government subsidized crop insurance? Who is bearing the risk of a failed crop and what might those risk-bearers want in exchange for assuming that risk?
• Consider the preceding question.  Who is "they" in the question?  HINT -- taxpayers.  What do taxpayers expect in return for taking on risk of a poor crop by allowing tax dollars be used to subsidize crop insurance?
• Who benefits if taxpayers assume some of the risk of crop failure?  Is the benefit shared by more than taxpayers?
• Consider crops and livestock that have been altered through biotechnology; who has invested what and what is the bio-tech entity entitled to receive (based on economic theory)? Is the developer of biotechnology entitled to a royalty payment?

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?

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Additional Applications of the Concept of Economic Resources

Reminder: 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.

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The following table represents the categories of resources used in a business.

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Table 2.

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Relationship Between Economic Resources and Financial Statements

Financial 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.

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Balance Sheet

The 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."

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Table 3.

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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.

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HINT -- the information on a balance sheet may be more valuable/useful to the business lenders than it is to the business manager.

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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.

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Table 4.  Categories of a Balance Sheet in which Business Resources are Summarized.

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Income Statement

A 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.

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Table 5. Sample Income Statement Illustrating Costs Associated with Categories of Economic Resources

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Return on Assets and Equity

Business 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).

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Table 6.  Components of Income Statement Where Compensation for Economic Resources are Reported

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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.

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Table 7. Economic Resources Whose Compensation is Included in Calculating ROA

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Note the similarities between tables 4 and 7.

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Table 8.  Example of Calculating Return on Assets

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.

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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

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Table 10.  Example of Calculating Return on Equity

The same discussion about opportunity cost for the owners' information, business reputation, and risk applies to this example of Return on Equity.

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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.

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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.

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Case Study (by Dr. Cole Gustafson, NDSU).

Each year during the annual meeting of the American Agricultural Economics Association, a pre-conference tour is arranged of surrounding agricultural firms.  At the 2006 meetings in Long Beach, California, the tour visited an almond cooperative, winery, and strawberry farm.  The strawberry farm tour was particularly interesting because the operation was so different than a traditional Midwest grain farm or livestock operation.

These differences were readily apparent as soon as we approached the farm.  The only building on the premises was a metal quonset with a small door for an office and larger garage door leading to storage.  No machinery was stored inside.  As we drove by, I could see several small tool boxes, but mostly pesticide boxes, plastic trays and boxes for picking, plastic sheeting, and other miscellaneous items.  There was no residence or farm house.

Behind the quonset was the operation's machinery complement.  Most of the equipment was over 20 years old and very faded from sitting outside.  The largest tractor was a John Deere 4440 that pulled a 2-way 4-bottom plow and disk.  The remaining tractors were 50 hp all-wheel-drive units.  There were numerous sprayers and wagons.  The owner later remarked that all of the equipment was leased from his father and uncles.

As we proceeded to the field, the owner greeted us.  He appeared to be about 40 years old, dressed in jeans.  In the background were 20 Hispanic workers planting new strawberry plants.  The field was perfectly level with hills every 20 inches.  Each hill had an irrigation line buried to provide water and was covered with black plastic.  The plastic was held down with dirt buried on its edges in the trench.  Periodically, holes were mechanically punched in the plastic and the workers were inserting new strawberry plants.

The owner explained that they plant several crops of strawberry plants each year.  Unlike Midwest berries, they were not perennials.  They were planted just for one harvest that was timed to provide produce for a delivery contract to a major national grocery chain.

The farm was located next to other strawberry operations.  Climatic conditions in the region were very favorable for strawberry production.  The owner mentioned that there were 5 or 6 operations in the area and together, they were the nation’s largest supplier.  Each operation was about 150-200 acres.

Looking across the field, we could not help notice that the farm was adjacent to a recently developed strip mall.  Across the other side of the field was a new housing development.  In fact, the farm was nearly surrounded with commercial and residential development.  Other strawberry farms in the area faced similar development pressure.

The owner was asked how he survived this pressure. He indicated the farm’s land is all rented from a family now residing on the east coast.  Development rights for the property had been sold long ago, and the land is only taxed at its agricultural use value.  If sold, the land would bring $60,000 acre (agricultural value).  Annual rent for the land is $2,500/acre.

Next, the owner described the labor force.  The people in the field did not actually work for him directly.  He hired them through an agency.  There are so many issues involved with hiring migrant farm labor in California that specialized agencies have emerged to hire, train, and pay these people.  The owner was then immune from any immigration, work place safety, or compensation issues.

When asked about production inputs, the owner described the sequence of field operations and quantities of inputs applied.  However, he remarked that all of the inputs were provided by the contract buyer of the crop to insure traceability and that proper procedures were utilized.  In fact, the contract buyer specified all application rates and windows for application.

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Who provided each of the economic resources in this farm operation?

• Who is providing the land?  A relative?
• Who is providing the labor? Employees, but a farmer labor contractor was the employer?
• Who is providing the management; that is, the decision making? The contract buyer?
• Who is providing the capital? In what form is the capital being provided -- equity or debt? Relatives were providing the equipment capital.
• Who is providing the information about production? Who is providing the information about marketing? In what form is the information being provided?  The contract buyer?
• What are the risks associated with this strawberry farm? Who is assuming these risks? How are some of these risks being managed?  The labor contractor and the contract buyer?  Note the reliance on contractual relationships.
• Whose business reputation is being relied upon to acquire the needed inputs and to sell the produce?  The contract buyer?

• Based on the answer to these questions, what economic resources is the farm owner providing? Is it appropriate to consider this person as the "owner" of the farm business? Why?
• Based on the answer to these questions, who is entitled to which economic returns? Why?
• How would you help this farmer determine whether he is receiving an adequate return for his business efforts?
• What are your observations about this business structure? Is this structure a future trend for production agriculture? Why?

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?

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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.

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The next topic suggests that management is decision making; such as, deciding how a business uses these economic resources to produce a product.

What provides resources needed by the company to produce goods and services?

What are the resources needed for business?

Which type of organization helps companies to stock and move goods from their points of origin?

Which of the following is a component of a firm's microenvironment?