3.5 Firms

Question 1

Primary sector

Answer 1

• Primary sector of industry extracts and uses the natural resources to produce raw materials used by other businesses or households.
• Businesses operating in primary sector are involved with the extraction, harvesting & conversion of natural resources. Examples include agriculture, fishing, mining, forestry & oil extraction.
• In less economically developing countries (LEDCs), the primary sector employs most of the work-force. There is little value added in primary production so people earn low income. Most people live in rural areas where there is low demand for manufactured products and services.
• Businesses operating in the primary sector in more economically developed countries (MEDCs) use mechanization and automation, such as combine harvesters and automatic watering systems.

As the economy develops, there is less reliance on the primary sector in terms of employment & national output.

Question 2

Economists will distinguish between different firms according to

Answer 2

• the industrial sector in which they operate
• whether they are privately owned, financed, and controlled in the private sector, or state-owned enterprises in the public sector
• their size or scale of production

Question 3

Secondary sector / Manufacturing sector

Answer 3

• The secondary sector of industry manufacturers the goods using raw material provided by the primary sector.
• Businesses that operate in the secondary sector are involved in the manufacturing or construction of products.
• Examples include: construction firms, pharmaceutical companies, clothes manufacturers, publishing firms, electronic manufacturers & energy production companies.
• Developing countries tend to have a dominant secondary sector. Secondary sector is considered as wealth creating sector because manufactured goods can be exported worldwide to earn income for the country as Value is added to the natural resources used during the production process. For example, mass production & export of motor vehicles & consumer electronic products have helped nations such as Taiwan & South Korea to develop. In such countries the secondary and tertiary sector employ more workers.
• When there is growth in the secondary sector in an economy, a country is said to be experiencing industrialization.
• Automation & mechanization in modern societies has seen this sector decline in terms of employment.

Question 4

Tertiary sector/ Service sector

Answer 4

• The tertiary sector of the industry provides services to consumer and business in other sectors of the industry.
• Examples of industries in the tertiary sector include: retailing, transport, banking, finance, insurance, education, healthcare, travel & tourism & entertainment. In most developed economic countries (MEDCs) such as Canada & Italy, the tertiary sector tends to be the most substantial sector in terms of both employment & as a percentage of GDP/national income/national output as they import manufactured goods from other countries.
• When there is decline in the manufacturing sector in an economy along with the rise of tertiary sector, a country is said to be experiencing de-industrialization.

Question 5

The relative importance of these sectors in the economy depends on the following two factors:

Answer 5

1. Percentage of total workforce of the country employed in these sectors
2. Percentage of the value of output generated by these sectors out of the value of total national output.

Question 6

Classification of firms based on the ownership

Answer 6

• Who owns the firm, who manages and controls the firms:
• In case of private individual or group of private individuals does so, then such firms are classified as private sector firms/organization. Mostly private sector firms have profit motive, therefore they strive to achieve efficiency.
• In case government owns, manages and controls the firms then such firms are known as public sector firm/organizations or public sector undertakings (PSUs) or state owned enterprises. Mostly PSUs have a motive to maximize social welfare.

Question 7

Sole trader

Answer 7

• A business organization owned, financed, and controlled by one person.
• This person receives the full profits but also has unlimited liability - they are personally responsible for any business debts.
• If the business suffers losses and ultimately becomes bankrupt, the personal assets of the owner can be used to pay off business debts. There is hardly any legal formality needed to set up the sole trader organization.

Question 8

Partnership

Answer 8

• A form of business in which two or more people agree to jointly own a business - but there is a limit to the maximum number of partners a partnership firm can have.
• They have relatively more resources at their disposal regarding finance (personal savings of all the partners and their contacts) and
• are relatively bigger in size than sole traders so they can get bank loans more easily.
• Work can be divided against partners but also delayed because all the partners need to be consulted unless otherwise stated.
• Unlimited liability and as the business is unincorporated if one partner dies or leaves the partnership dissolves.
• Partnerships can be formed without much legal formality,
• partnership deed/agreement is recommended but not required, can reach out to the court of law in case of any dispute among partners.

Question 9

Private limited companies

Answer 9

Are incorporated businesses, where owners or members are considered as shareholders, but shares cannot be sold to the public - rather they are issued to friends and relatives.

• Shareholders are not allowed to transfer the ownership of the shares freely to anybody - they have to inform the board of directors if they wish to transfer their shares.
• Shareholders get a dividend in return of their investment which is nothing but a share in profit.
• Liability of shareholders is limited to the amount of investments made by them - there is a limit on the maximum number of shareholders
• They have to submit two compulsory documents with the registrar of the companies - Article of association and Memorandum of association

Question 10

Public limited companies

Answer 10

• Is owned by shareholders, and any profits made by the company will belong to them.
• Can finance their operations from the sale of shares to investors through a stock exchange. They can go to the public to raise finance and issue stares.
• Is an incorporated business where shareholders/members have limited liability.
• need to file the Article of association and memorandum of association with the registrar of companies
• Have to publish their accounts

Question 11

Cooperatives

Answer 11

A cooperative is owned by its members, and managed and controlled by a board of directors appointed by its members. Aim is the welfare of members.

• Each member has one voting right in decision making
• Any surplus revenue not added to the reserves is distributed among the members

Question 12

Charity/ NGOs (Non-governmental organizations)

Answer 12

Can be set up and registered by a private individual or another organization for societal welfare but cannot be owned

• Are controlled and managed by board members which are often referred as trustees
• Sources of finance include grants, donations, revenue generated through organized events, etc.
• do not make a profit, any surplus income left over will be reinvested in the charity to fund the services it provides

Question 13

Internal economies of scale

Answer 13

• Reduce the average cost of producing each unit of output as the scale of production expands within a firm.
• There are five main types of internal economies of scale: Marketing, purchasing, financial, technical, and risk-bearing

Question 14

IoS: Purchasing economies of scale

Answer 14

• Large firms are often able to buy the materials, components, and other supplies they need in bulk due to the large scale of their production.
• Suppliers usually offer price discounts for bulk purchases as it is cheaper for them to make one large delivery to a single customer than several small deliveries to numerous small firms.

Question 15

IoS: Financial economies of scale

Answer 15

• Large firms are often able to borrow more money from banks than small firms and at a lower interest rate, as
• they are usually more financially secure and can offer more assets including property and other investments, to use as collateral against loans.
• Banks can sell these assets in the event that a firm fails and cannot repay its debts.
• Unlike small sole traders and private limited companies, large public limited companies are also able to sell shares through the global stock market to raise large amounts of money that never has to be repaid.

Question 16

IoS: Technical economies of scale

Answer 16

• Larger firms often have the financial resources available to invest in specialized machinery and equipment, to train and recruit highly skilled workers, and to research and develop new products and processes to increase the efficiency of their production.
• Smaller firms lack financial resources and their scale of production is often too small to justify such investments.

Question 17

IoS: Risk-bearing economies

Answer 17

• A large firm may have more customers, sell into more markets at home and overseas, and offer a wider range of products than a smaller firm.
• In this way, a large firm is able to reduce the risk to its business of losing one or more major customers or a fall in consumer demand on one of its product markets. - Producing a varied range of products and expanding into different consumer markets to reduce market risks is called diversification.

Question 18

External economies of scale

Answer 18

• Firms within an industry may also share additional cost advantages known as external economies of scale as the size of their industry increases.
• For example, average costs of production may be further reduced within firms in a particular industry because of access to skilled workers.

Question 19

EoS: Access to skilled workers

Answer 19

• The recruitment of skilled workers becomes easier as many other firms in the industry have already trained workers with the skills needed by the industry.
• Similarly, universities and colleges may develop courses to train workers with specialized skills required by large advanced industries such as the aerospace and pharmaceutical industries. This will reduce their training costs.

Question 20

EoS: Can benefit from shared infrastructure

Answer 20

• E.g. suppliers in other industries may find it profitable to invest in infrastructure improvements to meet the needs of a growing industry, including high-speed digital communication networks.
• Similarly, a government may invest in new road and railway links to encourage and benefit growing industries.

Question 21

EoS: Suppliers can also benefit from economies of scale

Answer 21

• Because they too are able to expand as the industry they supply grows.
• Suppliers can therefore lower the prices of the goods and services they supply to the industry without cutting their profit margins.

Question 22

EoS: Can benefit from specialist service providers

Answer 22

who develop to supply the specific requirements of a large industry for specialist equipment, transport, recruitment or marketing services.
- Universities may also invest in research and development facilities that firms within a large industry can use. It would not be profitable to provide specialist equipment or services for a much smaller industry.

Question 23

Agglomeration economies

Answer 23

• Agglomeration economies arise when similar firms within one or more industries co-locate or cluster together in the same geographical location.
• By locating together they can also encourage major business customers and suppliers to relocate close by, skilled labor to move to these areas, and investments in modern infrastructure.
• E.g. Silicon Valley

Question 24

Diseconomies of scale

Answer 24

• Occur when a business increases in the scale of operation/production, and average costs rise.
• An example is management diseconomies of scale, regarding the control and coordination of production in a firm.

Question 25

DoS: Management diseconomies

Answer 25

• Controlling and coordinating production in a large firm can be difficult especially if it produces and sells a wide variety of products in many different locations.
• So there will be many employees, many different levels of management which could cause
• communication and disagreement problems between managers at different levels in different parts of a firm.

Question 26

External diseconomies of scale

Answer 26

• Firms within an industry may also share additional cost disadvantages known as external diseconomies of scale as the size of their industry increases.
• For example, average costs of production may be further increased within firms in a particular industry because of a lack of access to skilled workers.

Question 27

DoS: Labor diseconomies

Answer 27

• It’s harder for senior managers to stay in day-to-day contact with employees in large firms that employ many hundreds of thousands of workers.
• Production is also automated in many large firms using computer-controlled equipment and machines.
• As a result, workers in large firms may not feel that their ideas and skills are valued by their managers,
• reducing their motivation with damaging consequences for output and quality.
• Labor disputes such as strikes may also occur if they feel like they are being treated unfairly.

Question 28

DoS: Supply constraints

Answer 28

• Some very large firms may need vast quantities of materials, components, or power for production.
• They may have to pay much more to obtain the supplies they need and they may also experience shortages that can hold up production.

Question 29

DoS: Skill shortages

Answer 29

• Some very large firms may be unable to attract enough workers with the right skills, and
• may have to spend more money on training their workers and increasing their wages to ensure that they do not leave to take jobs in other firms.

Question 30

DoS: Regulatory risks

Answer 30

• Some firms grow so large that smaller firms are unable to compete with them
• so they can dominate the market supply of a product and control its market price
• Large firms with dominant market positions in an economy may attract the attention of the government.
• It may introduce laws and regulations that control the prices charged by large firms and the quality of the services they provide
• the need to understand and comply with regulations will increase running costs in the affected firms

Question 31

State-owned enterprise (SOE)

Answer 31

• A firm or trading organization that is wholly or partially owned and operated by a government
• primarily to carry out commercial activities in order to earn revenues and,
• in many cases, to make profits
• e.g. state-owned railway, power company, airline

Question 32

Nationalization

Answer 32

• occurs when a government takes over the ownership of private sector organizations,
• e.g. through the compulsory purchase of all the shares in a private or public limited company

Question 33

Ways to measure and compare the size of firms

Answer 33

• how many workers they employ
• how they are organized
• how much capital they employ
• their market share

Question 34

Measure 1: number of employees

Answer 34

• Firms employing up to 50 employees are usually considered small while
• a micro-enterprise is generally defined as a small firm employing nine or fewer people
• however, just counting the number of employees a firm employs can be misleading, as \
• some large firms are capital-intensive and employ relatively few workers, instead using machinery and computer-controlled equipment to automate their production processes to mass-produce large quantities of output

Question 35

Measure 2: organization

Answer 35

• Large firms are often divided up into different departments specializing in particular functions, such as purchasing, sales, and marketing, finance, and production
• in smaller firms the owners and employees tend to carry out all the various functions between them
• Large firms may also have many different layers of management and different offices, factories and/or retail outlets spread across different locations, and in different countries if the firm is multinational

Question 36

Measure 3: capital employed

Answer 36

• the money invested in those productive assets in a firm that help it to generate revenue.
• They are assets used to produce and sell goods and services.
• Assets used in production include machinery, factory and office buildings, stocks of materials and components and money held by a firm to pay wages and other costs.
• the more capital-employed in a firm, the more it can produce and therefore the greater its size or scale of production
• However, some large firms are labor-intensive, so they require many workers, but relatively little capital

Question 37

Measure 4: market share

Answer 37

• market for any good or service consists of all those consumers willing and able to buy it no matter where they might be located.
• size of the market for a product is measured by the total amount spent by consumers on that product per week, month, or year.
• The bigger the market demand for a product, the more scope for an increase of scale of production for the firms supplying it
• share of the total market sales any one firm is able ot capture is its market share
• market share of a firm measures the proportion of total sales revenue or turnover that is attributable to that firm
• But all markets aren’t that large - local salon could be a very small business in terms of employees and capital employed, but have a very large share of the local market it serves because its the only salon in town

Question 38

Why are firms small and remain small

Answer 38

1. The size of their market is small
2. Limited access to capital
3. New technology has reduced the scale of production needed
4. Some business owners may simply choose to stay small

Question 39

The size of their market is small

Answer 39

• If there are only a relatively small number of consumers willing and able to buy a product there is no point in a firm supplying that market expanding in scale significantly
• sectors, where small firms thrive because the markets they serve tend to be localized, include hairdressers, restaurants, hotels, taxi services, etc.
• They are also able to offer their customers more innovative and personalized services than large firms that mass-produce goods or provide standard services across all their business locations. e.g. tailored suits or carpenters specially making furniture to order
• firms that produce luxury items may have relatively small or niche markets, as only consumers with very high incomes may be willing and able to pay high prices for ‘exclusive’ products such as designer accessories and sports cars

Question 40

Access to capital is limited

Answer 40

• banks are not normally willing to lend money to small, untested business propositions, as
• small firms usually lack assets they can offer as collateral against loans, face fierce competition from larger rivals, and may not make enough revenue regularly to repay the loan
• because lack of capital is a problem, many governments encourage new start-ups by providing grants to cover the costs of premises and equipment, or by subsidizing wages and other costs.
• May also benefit from lower tax rates in their progits, and can seek help and business advice on business issues from special advisers employed by government agencies.