3.5 Firms

Question 1

How are firms classified?

Answer 1

• Economic sector: primary, secondary, tertiary
• Public/private sector
• Relative size: number of employees, % of market share, profits, market capitalisation (shares x price)

Question 2

Why do small firms exist?

Answer 2

• Offer a more personalised service
• Difficult to access loans
• Niche market
• Operate in mass markets with low barriers to entry
• Rapid growth would cause diseconomies of scale
• Aim is satisfactory standard of living, not profit maximisation

Question 3

What are the advantages of small firms?

Answer 3

• Highly customised goods/services
• Personal relationships with customers
• Unique products
• Can respond quickly to changing market conditions

Question 4

What are the disadvantages of small firms?

Answer 4

• More susceptible to wider economic changes
• More difficult to access loans
• Wage/non-wage benefits worse than larger firms, hard to gain/keep staff
• Owners struggle to take holiday/sick leave
• Struggle to generate economies of scale, have lower profits

Question 5

How is organic growth usually generated?

Answer 5

• Gaining greater market share
• Product diversification
• Opening a new store
• Internal expansion
• Investment in new technology

Question 6

How is inorganic growth usually generated?

Answer 6

• Vertical integration (merger/takeover of firms further forward or back on the supply chain)
• Horizontal integration (merger/takeover of firms on the same stage of production)
• Conglomerate integration (merger/takeover of firms in different industries)

Question 7

What are the pros of organic growth?

Answer 7

• Manageable pace
• Less risky
• Avoids diseconomies of scale
• Management knows/understands all parts of the business

Question 8

What are the cons of organic growth?

Answer 8

• Pace can be slow
• May not benefit from economies of scale
• May have limited access to finance

Question 9

What are the pros of vertical integration?

Answer 9

• Reduces costs of production
• Firm more competitive
• Reduces risk of access to raw materials
• Raw material quality better controlled
• Additional profit
• Forward integration: brand visibility

Question 10

What are the cons of vertical integration?

Answer 10

• Diseconomies of scale
• May be culture clash
• Little expertise in new firms causes inefficiencies
• Price paid may take a long time to recoup

Question 11

What are the pros of horizontal integration?

Answer 11

• Rapid increase of market share
• Economies of scale (reduction of cost per unit)
• Reduces competition
• Existing knowledge of industry
• May gain new knowledge

Question 12

What are the cons of horizontal integration?

Answer 12

• Diseconomies of scale
• Culture clash

Question 13

What are the pros of conglomerate integration?

Answer 13

• Reduces risk of business failure
• Increased size/connection –> new opportunities for growth
• Duplicated parts of firm sold for profit

Question 14

What are the cons of conglomerate integration?

Answer 14

• Lack of expertise in new industry
• Diseconomies of scale
• Usually means job losses
• Worker dissatisfaction can reduce productivity

Question 15

What are economies/diseconomies of scale?

Answer 15

EoS: average costs decrease with increasing output
DoS: average costs increase with increasing output

Question 16

Give types of internal economies of scale

Answer 16

• Financial (lower interest rates on loans)
• Managerial (specialised managers)
• Marketing (spread costs over large numbers of sales)
• Purchasing (bulk purchase discount on raw materials)
• Technical (able to use machinery at higher capacity)
• Risk-bearing (spread risk of failure via product diversification)

Question 17

Give types of internal diseconomies of scale

Answer 17

• Management (self-interest over firm’s interest)
• Communication (slow responses)
• Geographical (communication)
• Cultural (clash)

Question 18

What are external economies of scale?

Answer 18

Benefits caused by an increase in the size of the industry in which a firm operates

Question 19

Give different sources of external economies of scale

Answer 19

• Geographic cluster (support firms move closer to major ones)
• Improved transport links
• Increase in skilled labour
• Support from government