Firms(Chapter 16)

Question 1

What is a firm

Answer 1

Firms play a crucial role in the production of goods and services. While resources are necessary, they alone cannot satisfy human needs and wants. Proper organization, financing, and decision-making within firms are essential for production to occur. Entrepreneurs and managers within firms make important decisions that determine the allocation and utilization of scarce resources. These decisions shape what goods and services are produced, how they are produced, and who they are produced for.

Question 2

Industrial sectors

Answer 2

Primary sector: this involves the use/extraction of natural resources. Examples include agricultural activities, mining, fishing, wood-cutting, oil drilling etc.

Secondary sector: this involves the manufacture of goods using the resources from the primary sector. Examples include auto-mobile manufacturing, steel industries, cloth production etc.

Tertiary sector: this consists of all the services provided in an economy. This includes hotels, travel agencies, hair salons, banks etc.

Question 3

Private sector firms

Answer 3

Most firms are owned and financed by private individual. Most aim to generate more revenue from their productive activities than their costs so that they earn a surplus or profit.

Question 4

types of firms in the private sector

Answer 4

Sole trader -
- owned by one person
- the owner is the main decision marker
- financing coming from the owners savings, the owner receives any profits but is also responsible for debts.

Joint-stock or limited company
- Is owned by one or more shareholders
- Managed by one or more directors appointed by its shareholders
- Financed by the sale of shares to shareholders
- Can only sell shares to private individuals
- Shares are sold through a public stock exchange.

Cooperative -
- Owned by its members
- Managed by a board of directors appointed by its members
- Financing from membership fees and drawing on reserves
- Member receive any surplus revenue that is not added to reserves

Charity -
- A charity can be set up and registered by a private individual or another organization to provide beneficial services for public benefit but it cannot be owned
- Run by its board of trustees
- Financing comes from gifts and donation from people and organizations.
- No profit

Question 5

SOE( state owned enterprises)

Answer 5

State-owned enterprises (SOEs) are government-owned firms that generate revenue and sometimes profits. They include railways, postal services, power companies, and airlines. SOEs reinvest profits or use them for public sector spending, while losses are covered by taxes and government revenues.

Question 6

Size of firms

Answer 6

1. Number of employees
2. Organization
3. Capital employed
4. Market share

Question 7

Why are so many firms small and remain small?

Answer 7

1. The size of their market is small - its products are usually are targeted to a small amount of people
2. Access to capital is limited - Small firms usually don’t get enough financing to buy enough capital.
3. New technology has reduced the scale of production needed - It’s smaller, cheaper, and more accessible.
4. Some business owners may simple choose to stay small

Question 8

Advantages of small firms

Answer 8

• Small firms can be set up easily with minimal legal requirements.
• They can operate from home or rented office spaces with little capital investment.
• Small firms may receive grants from local governments to support their establishment.
• In contrast to large firms where paid managers often run the business, small firms are typically managed by the owners themselves.
• The owners are highly motivated to run their businesses effectively and efficiently.
• They make decisions promptly and communicate them quickly to their employees.
• Being closely connected to both customers and employees, small firm owners build trust and loyalty.
• Small firms have the advantage of being able to respond swiftly to changes in economic and market conditions.
• The owners, as the main decision-makers, maintain close contact with customers, enabling them to understand shifts in customer preferences.
• With limited capital at stake, small firms can adapt their production processes and products based on factors such as weather conditions and market demands.

Question 9

Disadvantages of small firms

Answer 9

• Owners of small firms have full responsibility for daily operations, including accounts, advertising, staff management, customer relations, and more.
• They often lack the necessary skills for success
• They may work long hours and face business closure during illness or holidays unless they can hire someone to manage the business.
• Small firms are vulnerable due to limited financial resources, competition, and personal liability for business debts in case of failure.
• They struggle to raise capital for running costs and growth, as banks are reluctant to provide loans to risky businesses without substantial assets.
• Suppliers may also be hesitant to offer credit terms.
• Sole traders cannot sell shares like limited companies.
• Small firms face higher average costs compared to larger firms.
• They cannot benefit from bulk purchase discounts or afford specialized equipment and staff to improve efficiency and lower costs.

Question 10

Why do some firms grow in size?

Answer 10

In economics, firms can grow in the long run by expanding their scale of production through acquiring larger premises and more machinery. This allows them to improve efficiency and increase output. While the short run has fixed factors of production, such as capital, firms can still make use of existing resources to boost production. However, not all firms can or should remain small as larger firms can reduce risks, invest in better equipment, and employ specialized workers, leading to improved product quality and profitability. Despite initial costs, larger firms can gain cost advantages and capture a larger market share, ultimately increasing their total profits.

Question 11

Internal growth

Answer 11

Internal/organic growth involves a firm expanding its own scale of production through investments in new and additional equipment and technology, and increasing the size of its premises. This will increase its fixed costs of production.

Question 12

External Growth

Answer 12

External growth in the size of firms is more common. It involves one or more firms combining their factors of production to form a larger enterprise. This is known as integration through merger.

Question 13

What is a merger

Answer 13

A merger occurs when the owners of one or more firms, usually of a similar size, agree to combine their operations to form a new, larger enterprise. However, a merger can also result from the takeover or acquisition of a smaller public limited company by a larger one. This involves the larger company buying up all the shares of the smaller company with or without the agreement of its managers.

Question 14

Types of mergers

Answer 14

Horizontal merger - The consolidation of two or more firms operating in the same industry and at the same stage of production.

Advantages
- The combined business will have a larger market share;
- It will reduce the number of competing firms in the industry. This is called consolidation;
- Integrated firms can achieve cost advantages known as economies of scale through their increased size. By merging functions like finance, purchasing, and administration, the new firm can reduce costs and benefit from supplier discounts for bulk purchases.
- If common ownership results in the firms moving closer together geographically then it will reduce their transportation costs.

Disadvantages
- for the owners and managers because it may become more difficult to coordinate and manage the productive activities of a larger number of workers, especially if they are spread across many different locations. As a result production costs may rise;
- for consumers, because horizontal mergers can create large firms able to restrict market supply and competition in order to raise their prices and increase their profits.

Vertical merger - A vertical merger happens when firms at different stages of the supply chain merge, such as a car manufacturer merging with a car retailer for control over the sales process.

Advantages
- It can be certain it has a retailer through which it can promote and sell its cars and accessories;
- It can instruct the retailer not to stock vehicles produced by rival manufacturers;
- It can absorb the profit made by the retailer on each sale.

Question 15

Economies of scale

Answer 15

Economies of scale refer to the cost advantage experienced by a company when it increases its level of output.

There is an inverse relationship between per-unit fixed cost and quantity produced:
as output quantity increases per unit fixed cost and variable costs decrease.

An increase in the scale of production results in greater operational efficiencies and synergies.

Question 16

Internal economies of scale

Answer 16

Internal economies of scale reduce the average cost of producing each unit of output as the scale of production expands within a firm.

These are economies that are unique to a firm( eg. Firm may have a patent over a mass production machine , which lets it lower average costs of production)

There are five main types of internal economies of scale.

1. Marketing economies - Large firms can buy of hire there own marketing system, and distribution of goods increasing the reliability and efficiency of the distribution.
2. Purchasing economies - Companies can lower average costs by buying input require for production in bulk from whole salers.
3. Financial economies - Large firms can get lower rate of interest rate, from banks as they are more known and trust-worthy to the bank and have more assets than smaller businesses.
4. Technical economies - Technological advancement might drastically change the production process.
5. Risk bearing economies

Question 17

External economies of scale

Answer 17

The economies of scale faced by an entire industry( eg. the govt. announces a 20% tax break on steel producers who employed 10,000+ worker, lowering the average cost of production)

Benefits :
Access to a skilled workforce: As the industry grows, there is a larger pool of skilled workers available. The presence of other firms within the industry results in a skilled labor force that possesses the necessary expertise, reducing the need for extensive training programs for individual firms.

Shared infrastructure and improved services: With industry expansion, suppliers and infrastructure providers have incentives to invest in improvements.

Lower prices from suppliers: Suppliers serving the growing industry can also experience economies of scale. They benefit from increased demand and are able to expand their operations, resulting in lower prices for goods and services supplied to the industry. This allows firms to reduce costs without compromising their profit margins.

Access to specialized services: The growth of a large industry attracts specialist service providers who cater to its specific needs. Firms within the industry can benefit from these services without having to individually invest in costly resources

Question 18

Can some firms grow too much?

Answer 18

Yes, firms can indeed grow too large and encounter costly problems, leading to what is known as diseconomies of scale. Diseconomies of scale refer to the situation where a business grows to such an extent that its average costs start to rise. There are several types of diseconomies of scale:

1. Management diseconomies: As a firm expands, managing and coordinating production becomes increasingly challenging, especially when dealing with a wide variety of products and multiple locations. Communication problems and disagreements may arise between managers at different levels and in different parts of the firm.
2. Labour diseconomies: In large firms with hundreds or thousands of employees, it becomes harder for senior managers to maintain direct contact with workers. Automation and the use of computer-controlled equipment may lead to a perception among workers that their ideas and skills are undervalued, resulting in reduced motivation and potential negative impacts on output and quality. Labour disputes, such as strikes, can occur if workers feel ignored or treated unfairly.
3. Supply constraints: Some very large firms require vast quantities of materials, components, or power for their production processes. This high demand may lead to increased costs and potential shortages, which can disrupt production.
4. Skill shortages: Large firms may struggle to attract a sufficient number of workers with the required skills. This may necessitate increased spending on training programs and higher wages to retain employees who might otherwise seek employment opportunities in other firms.
5. Regulatory risks: When firms grow to dominate the market supply of a product and control its market price, they may face regulatory scrutiny from the government. Governments may introduce laws and regulations to control prices charged by large firms and ensure the quality of their services. Compliance with these regulations can increase operational costs for affected firms.