Theme 3.1 Flashcards
What determines the size of firms?
Factors include economies of scale, diseconomies of scale, monopoly power of small firms, profit motive, market power, diversification, and owner motives.
Economies of scale refer to cost advantages as production increases, while diseconomies of scale refer to rising costs when firms grow too large.
What are economies of scale?
Cost advantages that firms experience as they increase production relative to market size.
Large firms may experience limited economies of scale, leading to higher costs compared to smaller firms.
What are diseconomies of scale?
Increased costs that larger firms may face due to poor organization, x-inefficiency, or higher wages in large markets.
Diseconomies of scale can occur when firms grow too quickly.
How can small firms hold monopoly power?
By providing personal, local services and catering to niche markets, allowing them to charge higher prices.
An example is a small café competing with a multinational corporation.
What is the profit motive for firms?
The opportunity to earn higher profits and benefit from economies of scale without growing too large.
Growth must be managed to avoid diseconomies of scale.
What is market power?
The dominance of large firms over the market, enabling them to set prices and discourage new entrants.
Monopsony power allows firms to buy stock at lower prices.
What is diversification in business growth?
Expanding product range to reduce risk and make losses more manageable.
Diversification allows firms to have fallback options in different market areas.
What is the principal-agent problem?
A situation where agents act in their own interests rather than those of the principal due to asymmetric information.
This often occurs when owners sell shares and lose some control over the firm.
What characterizes public sector organizations?
Industries controlled by the government, aiming for social welfare rather than profit.
The NHS and nationalized railway industries are examples.
What are the objectives of private sector organizations?
To operate efficiently in the free market, maximizing profit and providing goods and services consumers want.
Private firms have profit incentives that public sector firms lack.
What is the primary goal of a profit organization?
To maximize the financial benefit of its shareholders and owners.
This includes earning maximum profits.
What is the goal of a not-for-profit organization?
To maximize social welfare while operating the organization.
Profits cannot be used outside of this goal.
What is organic growth?
Growth through expanding production, increasing output, or diversifying product ranges.
An example is Apple creating new products like iPads.
What are the advantages of organic growth?
- Less risky than inorganic growth
- Sustainable growth funded by retained profits
- Existing shareholders retain control
This reduces conflicts in objectives.
What are the disadvantages of organic growth?
- Long-term strategy
- Slower growth compared to inorganic methods
- Risk of competitors gaining market power
- Limited growth potential based on market strength
Shareholders may become unhappy with slow growth.
What is forward vertical integration?
Merging with or taking over a firm closer to the consumer, such as a distributor.
An example is a coffee producer buying a café.
What is backward vertical integration?
Merging with or taking over a firm closer to the producer, such as a supplier.
An example is a coffee producer buying a coffee farm.
What are the advantages of vertical integration?
- Increased efficiency
- More market control
- Certainty over production factors
This can lead to lower prices for consumers.
What are the disadvantages of vertical integration?
- Potential diseconomies of scale
- Barriers to entry for new firms
High market share can reduce incentives to lower costs.
What is horizontal integration?
The merger of two firms at the same stage of production in the same industry.
An example is two car manufacturers merging.
What are the advantages of horizontal integration?
- Rapid growth
- Competitive edge
- Shared expertise in marketing
However, it may lead to monopoly power.
What are the disadvantages of horizontal integration?
- Objective disagreements between merging firms
- Potential inefficiencies
Increased output can take advantage of economies of scale.
What is conglomerate integration?
The merging of two unrelated firms with no common connection.
An example is Associated British Foods owning Primark and Patak’s.
What are the advantages of conglomerate integration?
- Strengthens market position
- Wider customer base
- Economies of scale
Risk-bearing economies of scale can be beneficial.
