3.1

Question 1

What is a firm?

Answer 1

A firm is an organisation is that brings together all the factors of production in order to produce output.

Question 2

Why do businesses want to grow?

Answer 2

Profit motive- if businesses can expand and reach larger market more opportunities to make sales and therefore profit.

Cost motive (economies of scale)- cost per unit can fall.

Market power motive- a larger firm will have more power over the market
can control how the market works.

Risk motive- bigger business you operate in more locations you can spread the risk as if one town goes into decline.

Managerial motive- Managers have a desire to manage a large business

Question 3

Why may businesses want to stay small?

Answer 3

Low economies of scale- no benefit from economies of scale
Family business- want to stay small and keep family heritage
Niche Market- small target audience so can’t expand
Not for profit- no motive to expand for profit.
Owner wants to retain control-staying small can allow owner to make day to day choices
Associated legal costs- there are costs involved in registering a business.

Question 4

What is divorce of ownership and control?

Answer 4

The person who owns the business is not the person running the business.

Question 5

What is a PLC?

What are the objectives of owners and managers in this?

Answer 5

Public limited company
- shares sold on stock exchange
-many institutional owners 
Objectives of Owners.
-“owners” are interested in profits as it affects dividend and share price.

Objectives of managers and directors: (control with managers and directors).
Managers may be shareholders so profit is important.
Job security
Market share p

Question 6

What is the principal agent problem?

Who are the principals and who are the agents?

Answer 6

The principals do not know if the agents are maximising shareholder value in the short and long run.

Principals- shareholders
Managers- directors and senior management.

Question 7

What is the “moral hazard”

Answer 7

Managers are rewarded with big bonuses if they succeed but no sanctions if they fail. The shareholders are left to deal with repercussions.

Question 8

How can firms overcome principal agent problem?

Answer 8

Performance related pay- equity stake for employees.
Long term employment contracts.
Increased transparency between principals and managers

Question 9

What is satisficing?

Answer 9

When managers make enough profit to keep shareholders content but also follow other objectives,

• Corporate responsibilities.
• minimise possibility of a hostile bid.

Rational choice theory suggests may be impossible to calculate maximum profit so managers work towards acceptable level of profit.

Rational decision theory suggests that one person cannot make the decisions that keep people

Question 10

What are the three types of organisations?

Answer 10

Private sector- businesses must make a profit to survive as assets are owned by individuals or groups, not the government.

Public sector- survive without making a profit as assets are owned by society as a whole through government.

Not for profit- primary motive is not making profits, although they need to cover costs. To promote arts etc.