Ufa#ed2#sol#chap01

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CHAPTER 1

SUGGESTED SOLUTIONS SOLUTION TO MULTIPLE CHOICE QUESTIONS

1.1 1.2 1.3 1.4 1.5

(b) (d) (c) (b) (d)

1.6 1.7 1.8 1.9 1.10

(a) (e) (a) (c) (b)

1.11 1.12 1.13 1.14 1.15

(d) (a) (b) (e) (d)

END OF CHAPTER QUESTIONS

1.1 An ideology may be defined as a system of ideas that interprets reality from a particular perspective using a specific set of values. The ideology underlying a central planning system reflects a desire to share both resources and the results of economic activity between all of the participants in the economy. This result may be obtained at the expense of optimal efficiency. A free market economy, on the other hand, has as its dominant underlying ideology, the rewarding of those who use scarce resources in proportion to the benefits, which they generate from the use of those resources. This result may sometimes be achieved at the expense of fairness.

1.2 This question is intended as a basis for discussion within a tutorial group. One of the major problems in addressing a question of this nature is the distinction between reality and perception. It is likely that students from different backgrounds will have different perceptions of the underlying economic ideology, which presently exists in South Africa. Moreover such ideology is likely to be dynamic and continually adapting to the changing South African political environment. There is little doubt that the bulk of economic wealth and power lies in the hands of a relatively small sector of the population. It is also apparent that the free market system, albeit severely constrained in many instances, has been the intended economic policy of the government since 1994. It would seem that this economic ideology is likely to continue to be supported strongly by a large portion of the economic community, but may be accompanied by a distribution of resources to the less advantaged sectors of the economic community.

1.3 Economics is frequently defined as the study of endeavours to maximise the use of scarce resources. Every country has limitations on its resources, which comprise raw materials, land, labour and the entrepreneurial flair of its inhabitants. Regardless of the particular economic ideology, which may be propounded, all economic systems aim to make the best use of these limited resources. This inevitably implies that the cost of production of any item or the cost of services offered should be kept as low as possible and that work forces should be as productive as they are able within the constraints of prevailing educational levels and skills. It is thus apparent that the distinction between different economic ideologies is a more significant and controversial issue with regard to the distribution of the benefits of the economic system, than in respect of achieving the common objective of maximising the utilisation of scarce resources.

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1.4 This question covers a controversial and sensitive issue, which should be discussed by students in a tutorial session under the guidance of a lecturer or tutor. The discussion will inevitably move in the direction of the relative imbalance of wealth in South Africa. One issue to consider is whether the creation wealth in South Africa has been made possible only through the exploitation of the "have-nots", and the implication of this for the future. The distribution of wealth should be seen both in terms of remuneration packages paid to labour and other fringe benefits, which flow, from employment, as well as in terms of the distribution of profits to the providers of capital.

1.5 A comprehensive solution to this question appears in figure 1.3 on page 11, where full details of the differences between the different types of business enterprises are provided.

1.6 Jane Barnett is probably best advised to commence business as a sole proprietor. By forming a sole proprietorship, she will minimise the formation and running costs of her business. As the business is unlikely to incur significant debts other than for the acquisition of stock, the limited liability which a close corporation or company would afford her is not particularly necessary. Should she decide to form a company or close corporation, it is in any event likely that any individual or organization lending money to the business, or extending credit for large amounts of money, will require a personal guarantee for the amount from Jane Barnett. This tends to override the usefulness of limited liability. The capital of R40 000 which she has available is fairly limited for a venture which will require equipment as well as stock, so in this respect a partnership or close corporation may be preferable. However, from a control and a taxation point of view, Jane Barnett is better off forming a sole proprietorship.

1.7 Land: Without land, no activity can take place. Land, including sea is the source of all productive activity for the production of goods. The primary industries, including mainly agriculture, fishing and mining industries are the extractive industries from which raw materials and consumables are sourced. Enterprise: This is the ideas of people on how to create wealth by adding value. Every productive activity requires a person to initiate the activity, simple examples being to go to the sea and extract a fish, or to start a business manufacturing a product or retailing goods, or offering a service such as electrical, plumbing or medical. Labour: Nothing is achieved without human input, sowing the seeds, or producing the product, or performing the service. Savings: It the savings of individuals, who produce more than they need to consume, and use this to produce more goods. Another simple example is a farmer producing crops, not all of which is used, saving some in the form of seeds to plant further crops. Savings are all termed capital, which is money saved and then used for further production, such as to purchase machinery or factories, or any productive tangible asset.

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1.8 Any number of manufacturing activities can be listed, five examples of which are:  Assembling motor vehicles at a plant  Producing home appliances in a factory  Crafting jewellery  Building homes, offices and factories  Using carpentry to produce furniture

1.9 Five major retail store groups which operate in the country include the following, all of which are listed on the JSE Securities Exchange:     

Pick ‘n Pay Woolworths Truworths Foschini Joshua Doore Furniture

1.10 Five examples of service businesses are as follows:     

Medical Practitioners Banks Electrical Contractors Internet Service providers Lawyers

Fees from patients Bank Charges and Interest paid by clients Service fees charged to customers Monthly service costs Fees charged to clients

Most service business have salaries as a major cost item, as the nature of a service business is that it is labour intensive. In addition, consumables, such as stationery or other materials used in the service will be a significant cost item. The cost of the premises, either in the form of rent, or the cost of ownership of premises will also feature as a cost item for all service businesses.

1.11 The following are the most significant characteristics of a Close Corporation: From 1 to maximum 10 members Contributions by members Majority vote of members as per agreement Ownership transferable but offer to existing members first Limited unless personal guarantees provided Taxable income taxed at the current rate. Secondary tax on dividends Submit to the Registrar of Close Corporations signed by an  Reporting: accounting officer This form of business enterprise is most suited to small business. While there are some establishment costs, and legal requirements for submission of returns to the Registrar of Close Corporation, they are not onerous. The fact that a CC offers limited liability, makes it attractive to an entrepreneur.      

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Ownership: Capital contribution: Control: Continuity: Liability: Taxation:

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1.12 The following are considered to be some significant issues, which must be addressed before a business enterprise can be launched with any hope of success:  The type of business activity Where the market does not offer a particular product or service an individual may identify an opportunity to provide that product or service in such a way that the potential consumer will benefit and a profitable business with growth potential can be maintained. Some experience or specialised knowledge is usually required, but a goal directed entrepreneur could arrange that this be provided by employees. At this stage the entrepreneur usually engages in a strategy known as SWOT analysis in which careful consideration is given to the strengths and weaknesses of the business as well as the opportunities for and threats to the business. This analysis provides information with which the probable success of the business can be assessed. There is virtually no business opportunity, which does not have a risk of failure. It is this risk which must be assessed and weighed up against the potential for providing a return on the capital which will be invested.  The entity form The different entity forms have been discussed in an earlier section. This is a significant decision because of the impact on continuity and control of the business as well as factors such as taxation and regulatory responsibilities.  The location of the business It is sometimes difficult to choose the geographical location of a business, particularly in the case of a manufacturing business. Relative transport costs must be considered when deciding to either locate close to the source of raw materials or close to the market which will purchase the goods. The availability of suitable premises and the proximity of appropriate employees for the business will all contribute toward the probable success.  Capital requirements Virtually all types of business require capital in order to purchase the assets, which are required for the business to function. These assets include furniture, equipment, vehicles and stock of goods or consumable stores. In addition, the credit facilities customers or clients will be allowed will determine the amount of original capital required to commence business. Furthermore, funds for daily expenses and the payment of wages and salaries are required. Once the amount of capital required has been determined, a plan or budget of future revenue and expenses is drafted.

1.13 The amount of capital required will depend on the nature and size of the business to be commenced. The first distinction will be between the non current assets, such as Premises, Equipment, Machinery, Vehicles and Furniture required, and the current assets, such as Inventory, Debtors (which must be funded by the business) and cash resources which are required for daily operations. Each item will be listed and the amount of the investment required by collecting information and then drafting a budget. Consideration will be given to the amount of credit, which will be available from suppliers, based on the period of time which they offer for payment of accounts. This will reduce the capital required in the form of owners capital (in return for shares in the case of companies) and loans if required.

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1.14 Four major considerations are essential when planning to commence a business. They include the type of business activity, the entity form, the location of the business, and the capital requirements. A detailed strategic plan will be more comprehensive. It will include issues such as  The market niche  The customer base  The competitors  Sales forecasts  An analysis of the strengths, weaknesses, opportunities and threats (so called SWOT analysis)  A detailed budget of operational costs and capital expenditures, leading to a profit forecast for each year, taking at least a three-year time horizon. Each of these can be considered in the context of a plan to commence a business to manufacture home alarm systems. Such a business would most likely need to aim at a national (the whole of South Africa), rather than just to satisfy a local demand, although in its first year or two, it may target a local area, with a view to ultimately being competitive throughout the country. Consideration would also be given to the possibility of export to other countries in due course, should the product be successful.

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