3.1.1 Size and types of firms

Question 1

Reasons why some firms remain small

Answer 1

• Objectives of the owner
• Barriers to entry
• Access to finance
• Legislation
• Size of market

Question 2

Reasons why firms grow

Answer 2

• Economies of scale
• Diversification/cross-subsidisation
• Control of resources
• Patent/copyright
• Successful risk taking
• Market power (Monopoly, Monopsony, Oligopoly)

Question 3

Divorce of Ownership & Control

Answer 3

As firms grow, the owners (or shareholders) often appoint managers to run the business for them.

There is a separation (divorce) between the owners and the managers who control the day-to-day running of the business.

This divorce gives rise to the principal-agent problem.

Question 4

Principle Agent Problem

Answer 4

The principal-agent problem occurs when the owner (principal) is no longer in full control and so managers (agents) may have a different set of objectives.

This creates divergent aims, meaning not everyone in the firm (owners and managers) agree in the direction of a company.
* E.g. Shareholders want to maximise their profits, but workers want to maximise their salaries

If managers are shareholders, then they will be likely to align their interests more with those of the owners.

Question 5

How might owners maintain control of a business?

Answer 5

Accountability and incentives

Shareholders can remove directors if they’re not happy with them.

Accountability means managers/directors have to justify what they’ve done in the past and explain the future plans and intentions.

Owners may also try to encourage directors to aim for profit maximisation by offering incentives (e.g. bonuses linked to profits).

Question 6

Public sector organisation

Answer 6

Public sector organisations are owned & controlled by the Government. Their goal is not profit maximisation – it is to provide a service.

Question 7

Examples of public sector organisations

Answer 7

• Corporations like the BBC and Channel 4.
• National services such as State Schools & National Health Service Trusts.
• Local services such as Transport for Greater Manchester.
• Civil service departments such as Defence, Police, Education.
• Regulatory bodies such as OFCOM.

Question 8

Private sector organisations

Answer 8

Private sector organisations are owned & controlled by private individuals.

Question 9

What is the goal of private sector organisations?

Answer 9

Profit maximisation. - This often causes the private sector to be more efficient than the public sector with higher levels of productivity.

Question 10

What are not-for-profit organisations?

Answer 10

Organisations that exist to provide a service or meet a need:

• Many sell goods/services & use the profits they generate to further their objectives, e.g. The British Heart Foundation.
• The government exempts them from paying direct taxes.
  All Charities are not-for-profit organisations and are regulated by the UK Charity Commission.