3.1.1 - Sizes and types of Firms Flashcards
Define Economy of Scale
.When the average costs per output decreases when the magnitude of output increases
Explain reasons why some firms remain small
(Evaluation for Business Growth)
1.) Business can be productively inefficient if they become too large and suffer from diseconomies of scale. This is when average costs are rising, due to problems with communication and motivation where productivity is reduced due to excessive size of the firm. As a consequence cost of production increases for firms, increasing prices and reducing consumer surplus. This would also reduce demand and thus revenue and profit for firms.
2.) Excessive business growth could result in investigation by authorities. This is a higher profits may be down to monopoly or collusive price beyond marginal costs (consumer exploitation). This can result in forced price reductions, improvements of working conditions, etc. This increases cost of production for firms
3.) Company that provide a niche product may struggle to expand. This is because the market has a limited size and maximum ceiling for growth due to a smaller number of consumers. As a consequence, firms have to stay small or consider overseas investment
An example of an niche market is vegan meat market.
Define Diseconomy of Scale
. Diseconomies of scale happen when a company or business grows so large that the costs per unit increase
. When a firms experiences increasing marginal cost per additional unit of output
Reasons for Diseconomies of Scale
. Communication breakdown when managing large work force. They may be a lack of managers in place.
. Lack of motivation due to large work force so labour productivity falls. This increases cost per unit of output
. Workers may demand higher wages as firms grow. This could increase cost of production
Reasons for Economy of scale
. Specialisation of labour increases as company grows
. Low per unit costs came come from bulk orders from larger firms. This reduces the cost of production.
Explain the Significance of the divorce of ownership from control: the principal-agent problem
(Cost of Business Growth)
(Reason why a firm may choose to stay small)
. As a firm experiences substantiable growth (shareholders) are not involved in the running of a firm. They are represented by the board of directors.
. There is a divorce of ownership from control; this is an example of the principal - agent problem.
. The agent (board of directors) is making decisions on behalf of the principal (shareholders). In theory, agents should maximise the benefits for whom they are looking after. In practice, agents may maximise their own benefits.
. There is a differing aim between the agent and principal :
1.) Shareholders want to maximise their return on their investment so they short run profit maximise
2.) Directors and managers maximise their own benefits
. For example, board of directors may awarding themselves bonuses or increased wages. If there is a takeover bid there is a temptation for for directors to accept or reject according to what will benefit them rather than what will benefit shareholders
. It is for this reason most firms are not run to profit maximise but to profit satisfice.
. Shareholders have some control over directors through Annual General Meeting (AGM). They can vote directors off the board
Two sets of Organisations
Public Sector Organisations
Private Sector Organisations
Profit Organisations
Non - Profit Organisations
Define Public Sector Organisations
. Organisations that are controlled by the state such as BBC
. Some make profits whilst other don’t but the main purpose is to provide a service to the people
Define Private Sector Organisations
. Organisations owned by individuals or companies and not the state
Define Profit Organisations
. Organisations whose main aim is make profit and maximise the benefits for their shareholders
Define Non Profit Organisations
. Organisations that do not have making profit their goal but use any profit made to support their aims. They maximise social welfare
. Includes charities such as Water Aid or RSPCA
Advantages of Business Growth
1.) As a business grows in size, producing and selling more output, profits rise allowing greater dynamic efficiency
Profit can then be reinvested into the company in the form of technology advances and R&D. This benefits consumers who receive, brand new, better quality products. Furthermore, prices could be lower over time if technology advances reduces costs for businesses, which are then passed onto consumers, which would increase demand for goods and services. The choice available to consumers would increase too.
2.) Growth allows business to experience economies of scale, reducing average costs. This results in a competitive advantage over rivalling firms. Furthermore, lower costs lead to lower prices to consumers, which increases demand for goods and services. This can lead to an increased market share and increased control over prices
3.) Growth allows business to flood the market with products developing the brand and establishing their presence. This increases brand loyalty amongst consumers. This can increase market share and result in monopoly power.
4.) Directors, managers and staff may be able to justify higher salaries and bonuses if a business experiences growth. This incentives them to profit maximise as this will benefit the shareholder through dividends. Furthermore, labour will be more productive as they will be more motivated if they can get bonuses. This reduces cost of production for firms, which increases profits.
However, this leads to a divorce of ownership from control
