3.1.1 Sizes and Types of Firms

Question 1

why might some firms tend to remain small and why might others grow?

Answer 1

1. Economies of Scale: Economies of scale are cost advantages that a firm can achieve as it increases its level of output. A large manufacturing company can produce more units of a product at a lower cost per unit compared to a small, local producer. This cost advantage can allow large firms to expand and grow. Similarly, a firm may choose to remain small to avoid diseconomies of scale.
2. Market Demand: Firms may remain small if the market demand for their product or service is limited. In contrast, those with high demand may grow to meet it. A niche gourmet chocolate shop may stay small due to a niche market, while a fast-food chain like McDonald’s grows due to widespread demand.
3. Access to Capital: Availability of funds plays a crucial role in growth. Small startups may struggle to secure investment, while established companies with a proven track record can easily raise capital to expand.
4. Managerial Capacity: Some entrepreneurs may lack the skills or resources required to manage a large organization effectively. A skilled craftsman might prefer to run a small boutique shop rather than a large factory.
5. Government Regulations: Regulatory barriers can hinder or promote growth in specific industries. Taxi companies may remain small due to government regulations, while tech startups can grow rapidly with fewer restrictions.

Question 2

Describe managerial diseconomies of scale and possible causes

Answer 2

Definition of Principal-Agent Problem: The interests of the owner (principal) and the manager (agent) of a firm do not align, leading to conflicts.
Causes:
1. Misaligned Incentives: Managers may prioritize personal gain over maximizing shareholder wealth. CEOs receiving large bonuses even if company performance declines, leading to shareholders losing value.
2. Risk Aversion: Managers may avoid taking risks that could benefit the firm but endanger their job security. Managers may resist long-term investments in research and development due to the uncertainty involved.

Question 3

What are some solutions to the principal-agent problem?

Answer 3

Various mechanisms like performance-based pay, monitoring, and corporate governance are used to align interests.
Example: Stock options and bonuses tied to company performance can align the interests of managers and shareholders.

Question 4

What is the Distinction between public and private sector organisations?

Answer 4

1. Ownership and Control: Public sector organizations are owned and controlled by the government, while private sector organizations are owned by private individuals or entities.
2. Profit Motive: Private sector firms aim to generate profits, while public sector organizations often provide services without a profit motive.
3. Funding Source: Public sector organizations are funded through taxes and government budgets, while private sector organizations rely on investments, loans, and revenue.

Question 5

What is the Distinction between profit and not-for-profit organisations?

Answer 5

1. Profit Orientation: Profit organizations aim to generate income that exceeds their expenses, while not-for-profit organizations prioritize their mission over profit.
2. Revenue Sources: Profit organizations primarily rely on sales and investments for revenue, while not-for-profit organizations may depend on donations and grants.
3. Distribution of Surplus: Profit organizations distribute surplus (profits) to shareholders or reinvest it, whereas not-for-profits reinvest surplus in their mission.