3.1.1 - SIzes and types of firms

Question 1

Why do firms seek growth (5)

Answer 1

Profit, costs, managerial objectives, diversification and market power

Question 2

Why is profit a reason for a firm’s growth

Answer 2

• Increasing in size enables a firm to produce more goods and services.
  -This allows for an increase in sales which would boost revenue. - - Higher revenue means higher profit.
  -This is beneficial for firms in several ways e.g. it allows for increased investment
• firms can achieve profit from growth bc growth leads to increasing economies of scale (reach minimum efficent scale of production), increasing market share and reducing comp, expanding inot new markets

Question 3

Costs as a reason for a firm’s growth

Answer 3

• A firm that increases in size often experiences lower unit costs as a result i.e. economies of scale
• a firm might grow to reach the minimum efficient scale of production so Long run average costs are minmised

Question 4

Market power as a reason for a firm’s growth

Answer 4

• if a firm grows they will gain market power hence they gain some monopoly power which allows them to set prices and make supernormal profits as well as restrict entry to market for new firms

Question 5

Diversification as a reason for growth

Answer 5

• A firm may expand in size through entering a foreign market or producing a new good/service
• ## it reduces risk e.g if one country experiences recession, firm can rely on sales from other countries to sustain the business

Question 6

Managerial objectives as a reason for growth

Answer 6

• Managers often have renumeration packages that are determined by the sales performance
  of their firms.
• This provides an incentive for managers to increase the size of their firms.
• Managers may also seek to increase the size of their firms to satisfy their ego: leading a large firm can command respect and veneration from others.

Question 7

Why do some firms CHOOSE remain small?

Answer 7

• Diseconomies of scale
  +(cost per unit increases with expansion
• don’t want extra work/risk,
  + (expansion involves sunk costs which cannot be recovered if the expansion is a failure e.g. a firm failing to enter a new market (money is lost on marketing, capital,
  labour etc).
• legal requirements get bigger
  + Smaller firms generally face less, and
  more easily compliable, regulations than larger firms. Staying small can thus allow for a more manageable regulatory framework for firms.

Question 8

Why are some firms forced to stay small

Answer 8

• cannot fund expansion
  + . Banks generally see small firms as risky
  borrowers so only offer credit on strict terms or not at all.
• They operate in a niche market which has a small customer base e.g. luxury yachts
• The skills, knowledge, and expertise required may be lacking.
  + Not every business will possess entrepreneurs with the ability to steer a business through a successful expansion.
• The firm may lack the resources to cope with additional regulations and bureaucracy that expansion entails.

Question 9

Significance of the divorce of ownership from control:
the principal-agent problem

Question 10

Define principal agent problem

Answer 10

This is an asymmetric information problem. Owners often cannot observe directly the day-to-day decisions of management. The performance of the agent is costly and difficult to monitor. Managers may have different objectives than owners.

Question 11

Define private sector

Answer 11

All privately owned businesses and organisations. These businesses usually aim to return a profit to the owners.

Question 12

Define public sectore

Answer 12

Public sector organisations are owned and operated by the government – in the UK this includes the National Health Service and state education.

Question 13

Define shareholder value

Answer 13

total return (dividends + increases in business value) for shareholders.

Question 14

Define divorce of ownership control

Answer 14

This occurs when the owners of a business do not control the day-to-day decisions made in the business. The owners of a company normally elect a Board of Directors to control the business’s resources for them.

Question 15

Define incumbent firms

Answer 15

Firms already in the market – established firms may be able to use barriers to entry

Question 16

Define structural barrier to entry

Answer 16

Cost advantages of existing, established firms in a market – they might have benefitted from economies of scale, vertical integration and built up high levels of customer loyalty. This makes it more expensive for a new firm to enter
successfully

Question 17

Define innocent barriers to entry

Answer 17

Also known as structural entry barriers – arise when established firms have lower unit costs than potential rival firms. Might come about from first mover advantage

Question 18

What is the private sector, what is their aimand who is involved

Answer 18

• Private-sector firms are those that are not owned by the government. They may be owned by shareholders (can/not be trading on stock market
• Private-sector firms will aim to make a profit to satisfy the demands of their owners.
• Private-sector firms also include sole proprietors, which are owned and run by one person, such as a newsagent. Accountancy and legal firms form partnerships, which are owned by
  the partners.

Question 19

What is the public sector

Answer 19

• The government may own certain businesses, either because they could not survive without significant state funding or because the government wishes to determine the direction the
  business takes.
• owned by the government and run on the basis that it will not make aprofit for shareholders but instead will reinvest any surplus funds

Question 20

What is not for profit

Answer 20

• The not-for-profit sector consists of charities, sometimes known as the third sector or civil society, which exist to provide services to local, national and international communities, and
  do not see profit as the primary goal.

Question 21

Briefly describe the prinicipal agent problem

Answer 21

• The principal is the shareholder or owner of a business, while the person incharge of the day-to-day running of the business is referred to as the agent.
• In such cases the agent can make decisions on behalf of the business that do not necessarily match the direction in which the owners would like to take the business.
• agent should act in principal’s interests but instead acts in self interest e.g max revenue or sales rathe than profit (return on owners shares)

Question 22

Why does the principal agent problem arise

Answer 22

Divorce of ownership - where there are a large number of shareholders, the day-to-day management of
the business is delegated to a board of directors and from them to their managers.
- but shareholders can remover a director by vote (might lack info to do this though)
- or link incentives to make directors act in owners’s interest like bonus linked to profit max