LS1 - Size And Types Of Firms

Question 1

Reasons why firms seek growth

Answer 1

Profit - increase in size enables a firm to produce more goods and services, increase in sales leads to higher Rev and profits which can be used for investment
Costs - firm that increases in size often experiences lower unit costs as a result (economies of scale) allowing for higher profit
Market power - larger the firm the higher the market power (which is the ability of a firm to raise prices and earn supernormal profit)
Diversification - diversification = increasing the range of products or markets served by a business. Diversification is beneficial to firms because it reduces risk
Managerial objectives - managers have renumeration packages that are determined by the sales performance of their firms (CEOs often receive bonuses for meeting sales targets, providing an incentive for managers to increase size of firms. Managers may also seek this to satisfy their ego and gain respect from others)

Question 2

Reasons why some firms choose to remain small

Answer 2

Worried about experiencing diseconomies of scale (costs rise as output increases)
Firms owners don’t want extra work in expanding
Legal requirements differ by firm size - smaller firms generally face less and more compliable regulations than larger firms

Question 3

Reasons why some firms must remain small

Answer 3

Unable to finance expansion - banks see small firms as risky borrowers so only offer credit on strict terms or not at all
Operate in niche market with a small customer base
Skills, knowledge and expertise may be lacking
Firm may lack the resources to cope with additional regulations and bureaucracy that expansion retails

Question 4

Types of firm

Answer 4

Private sector - not owned by government, aim to make profit to satisfy demands of their owners
Public sector - owned by government as either they couldn’t survive without significant state funding or gov wants to determine the direction the business takes
Not for profit - charities etc. Provide services to local, national and international communities and don’t see profit as the primary goal

Question 5

Principle agent problem

Answer 5

Principal - shareholders/owners of a business
Agent - in charge of running day to day operations of business
Problem is that the agent may behave in ways that don’t satisfy the principal, without their approval or awareness