Unit 4 The private firm as producer Unit 4 The private firm as producer and employer

and employer
Activities: Guidance and answers
Activity 4.1 The sole trader
• Advantages of running a business as a sole trader: it is easy to set up; there are
few legal requirements; the owner is his or her own boss and has full control
over the business; the owner receives all profits after tax and therefore has an
incentive to work hard; separate accounts are not required for the business
• Disadvantages of running a business as a sole trader: there is a high risk of
failure; the owner has full responsibility for running the business; the owner
may have to work long hours; the business may lose revenue and profits
if the owner is off sick or on holiday; the owner has unlimited liability to
repay any business debts; the owner may lack all the skills needed to run a
successful business; the owner may lack capital to finance business growth.

Activity 4.2 Building a partnership

• Advantages of partnerships: they are relatively easy to set up; the partners
invest new capital into the business to finance expansion and share financial
risks; the partners bring new skills and ideas into a business; the partners
share responsibilities for decision making and managing the business.
• Disadvantages of partnerships: the partners can disagree; general partners
have an unlimited liability for business debts; problems can arise if one or
more partners are lazy, inefficient or even dishonest; the partners can lack
capital to finance business growth because many countries place a limit on
the number of partners allowed in each partnership.

Activity 4.3 Expanding privately

• Private limited companies raise capital by selling shares.
• Shareholders will receive dividends from the company’s profits. Shareholders
will also have limited liability. This means they will only lose the amount
they invested in the company if it fails. They will not be responsible for
repaying any company debts. They also have the chance to be involved in
the performance of a company: they can vote on major decisions and elect
directors they think will manage the business well on their behalf.
• The shareholders will elect a board of directors to run their company.
• Advantages of a private limited company: shareholders can elect directors
to manage the business on their behalf; shareholders receive dividends from
profits; limited companies have a separate legal identity from their owners
– this means shareholders have limited liability; the sale of shares can raise
significant capital; unlike bank loans, share capital does not need to be repaid
by the company and there are no interest charges.
• Disadvantages of a private limited company: it can be more expensive to
set up; limited companies are legally required to publish detailed financial
accounts and to hold annual general meetings (AGMs) with shareholders;
people holding many shares can out vote smaller shareholders on decisions
that affect the company; directors may run the company in their own

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 Unit 4 The private firm as producer and employer

interests rather than in the best interests of the shareholders; shares can only
be sold privately with the agreement of all other shareholders – this may
restrict the amount of share capital a private limited company can raise.

Activity 4.4 Going public

• A public limited company can advertise and sell its shares to the general
public on the stock market.
• BBS plans to raise $15 million (i.e. 1,500,000 shares × $10 each).
• The original owners are more at risk of losing control of their company if they
hold less than 51% of the shares.
• Advantages of a public limited company: it can raise significant capital
through selling shares on a stock exchange; it can advertise the sale of shares
to the general public; shareholders can elect directors with key business skills
to manage the business on their behalf; shareholders receive dividends from
profits; shareholders have limited liability.
• Disadvantages of a public limited company: it can be expensive to form a
public limited company as many legal documents and company investigations
are needed before a company can be listed on a stock exchange; it is required
by law to publish detailed annual reports and accounts and to hold AGMs
with shareholders; the original owners can lose overall control of their
company unless they keep a controlling interest of at least 51% of all shares
so they can out vote all other shareholders on major company decisions;
directors may run a company in their own interests rather than in the best
interests of the company’s shareholders.

Activity 4.5 Types of business organization

Partnerships
Advantages
+ Partnerships are relatively easy to set up.
There are few legal requirements involved
in drawing up a partnership agreement or
deed of partnership.
+ Partners invest new capital into the
business to finance expansion.
+ Partners bring new skills and ideas into
a business.
+ Partners share responsibilities for decision
making and managing the business.
+ Partners share any profits and are therefore
motivated to work hard.
+ Partners share business and financial risks,
but limited partners have limited liability.
Disadvantages
- Discussion between partners can slow down
decision making and they may disagree on
important business decisions.
- Problems can arise if one or more partners
are lazy, inefficient or even dishonest. There
may be arguments, the business may lose
money and other partners will have to
work harder.
- General partners have an unlimited liability
to repay any business debts.
- Raising additional capital to finance further
business expansion can be difficult, because
many countries place a limit on the number
of partners allowed in each partnership.

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Private limited company
Advantages
+ Shareholders can elect directors to manage
the business on their behalf.
+ Shareholders receive dividends from profits.
+ Limited companies have a separate legal
identity from their owners.
+ Shareholders have limited liability.
+ The sale of shares can raise
significant capital.
+ Private limited companies are a popular
form of organization for family businesses
or partnerships looking to raise additional
capital to expand their businesses.
Public limited company
Advantages
+ A public limited company can advertise
new issues of shares for sale using
a prospectus.
+ The public sale of shares through the stock
market can raise significant capital.
+ Shareholders can elect directors with key
business skills to manage the business on
their behalf.
+ Shareholders receive dividends from profits.
+ Limited companies have a separate legal
identity from their owners.
+ Shareholders have limited liability.
© Brian Titley 2012: this may be reproduced for class use solely for the purchaser’s institute
Unit 4 The private firm as producer and employer
Disadvantages
- Private limited companies are legally
required to keep detailed annual accounts
of their revenues and profits, fixed and
working capital, loans and other liabilities,
shareholdings, dividend payments and
directors’ salaries.
- Large shareholders can out vote others on
decisions that affect the company.
- Directors may run a company in their own
interests rather than in the best interests of
the company’s shareholders.
- Shares can only be sold privately and
only with the agreement of all other
shareholders. This may make new investors
unwilling to buy shares as they may be
unable to sell them quickly if they want
their money back.
Disadvantages
- It can be expensive to form a public limited
company. Many legal documents and
company investigations are needed before a
company can be listed on a stock exchange
to sell shares.
- Public limited companies are required
by law to publish detailed annual
reports and accounts and to hold AGMs
with shareholders.
- The original owners can lose overall control
of their company unless they keep a
controlling interest of at least 51% of all
shares in the company. In this way they can
out vote all other shareholders on major
company decisions.
- The original owners may also lose control
of their company if it is taken over by
another. A takeover or acquisition occurs
when one company buys enough shares in
the ownership of another firm so it can out
vote the owners of that company and take
overall control.
- Directors may run a company in their own
interests rather than in the best interests of
the company’s shareholders.
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 Unit 4 The private firm as producer and employer

Activity 4.6 Global giants

Company Country of origin Main business acivities
Volkswagen Germany Automotive
Carrefour France Retailing (supermarkets)
General Electric USA High-tech manufacturing, services and finance
Siemens Germany Electronics and electrical engineering
Sinopec China Petrochemicals
Samsung South Korea Advanced manufacturing and electronics
Nestlé Switzerland Food and nutrition
HSBC Holdings UK Banking and finance
ArcelorMittal Luxembourg Steel

Activity 4.7 The ownership, control and finance

of different firms
Type of business organization
Sole trader Partnership Private limited Public limited Worker Consumer
company company cooperative cooperative
Ownership Single person Partners Shareholders Shareholders Members, i.e. Members, i.e.
employees customers and
of the shareholders
organization
Control Owner Partners Board of Board of Board of Board of
manages manage directors directors directors directors
and makes and makes elected by elected by elected by elected by
decisions decisions shareholders shareholders members members
Main sources Own funds Partners’ funds; Private sales of Public sales Members’ own Members’ own
of finance loans shares of shares on funds; loans funds; loans
stock market
Distribution Owner receives Profits shared Profits Profits Profits shared Profits shared
of profits all profits between distributed to distributed to by members by members,
partners shareholders shareholders as ‘stamps’ or
in proportion as dividends as dividends price discounts
to their per share per share
investments

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 Unit 4 The private firm as producer and employer

Activity 4.8 Dough!

1 The chain of production for bread may be as follows.
3 Farms plant seeds to grow wheat
7 Wheat is harvested
8 I nsurance firms provide insurance to protect farms from risk of damage
or theft
13 Commercial banks provide loans and payment services for farmers
5 R
 oad haulage service providers transport harvested wheat and
finished breads
8 I nsurance firms provide insurance to protect road haulage companies from
risk of damage or theft
13 C
 ommercial banks provide loans and payment services for road
haulage companies
1 W
 heat, water, yeast and other ingredients are mixed together to
produce dough
2 Coal and oil are used to power electricity stations for use by the bakery
8 I nsurance firms provide insurance to protect the bakery from risk
of damage or theft
13 Commercial banks provide loans and payment services for the bakery
9 Dough is poured into baking pans and placed in ovens to cook
14 F
 ood inspectors check the quality and hygiene of the breads and the
bakery
10 S
 ealed packets for the bread are produced and labelled in
printing machines
12 Finished loaves of bread are sealed in plastic packaging
5 R
 oad haulage service providers transport harvested wheat and
finished breads
4 Supermarkets and other shop sell bread to consumers
2 C
 oal and oil are used to power electricity stations for use by firms
and households
8 I nsurance firms provide insurance to protect supermarkets from risk of
damage or theft
13 Commercial banks provide loans and payment services for the bakery
6 Consumers buy bread
2 C
 oal and oil are used to power electricity stations for household
consumption
11 Consumers make sandwiches or toast to consume
13 Commercial banks provide loans and payment services for households
2 The task is your own research into the chain of productive activities in the
production and sale of six different products.

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 Unit 4 The private firm as producer and employer

Activity 4.9 Which stage of production?

1

Picture Activity Industrial sector

1 Wheat, water, yeast and other ingredients are mixed together to produce dough Secondary
2 Coal and oil are used to power electricity stations for use by firms and households Secondary
3 Farms plant seeds to grow wheat Primary
4 Supermarkets and other shops sell bread to consumers Tertiary
5 Road haulage service providers transport harvested wheat and finished breads Tertiary
6 Consumers buy bread Tertiary
7 Wheat is harvested Primary
8 Insurance firms provide insurance to protect firms from risk of damage or theft. Tertiary
9 Dough is poured into baking pans and placed in ovens to cook Secondary
10 Sealed packets for the bread are produced and labelled in printing machines Secondary
11 Consumers makes sandwiches or toast to consume -
12 Finished loaves of bread are sealed in plastic packaging Secondary
13 Commercial banks provide loans and payment services to firms Tertiary
14 Food inspectors check the quality and hygiene of the breads and the bakery Tertiary

Primary Secondary Tertiary

Fishing Construction Television broadcasting
Forestry Furniture making Film making
Farming Engineering Decorating
Mining Shipbuilding Health service
Chemicals Banking
Manufacture of motor Hotels
vehicles Retailing
Advertising
Universities
Restaurants

Activity 4.10 March of the robots

1 They can reduce labour requirements and costs; they can be used
continuously and increase productivity; average costs of production are
reduced; product quality can rise; firms will become more competitive.
2 Industrial robots can undertake tasks formerly carried out by employees. They
can therefore replace labour in production processes.
3 Workers may be made redundant if robots replace them. Productivity may
rise, thereby reducing business costs. Cost savings may be passed onto
consumers through lower prices. Product quality may also increase.
4 They can be expensive; business managers may not be aware of their benefits
workers may not have the skills to use them efficiently; trade unions may
resist their introduction if it means workers will lose their jobs.

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 Unit 4 The private firm as producer and employer

Activity 4.11 The Bear Necessities

1 They are costs that do not vary with output. Examples include rents, loan
repayments, insurance premiums, lease payments for equipment and
depreciation.
2 $200
3 $200
4 They are production costs that vary directly with the amount of output, for
example cost of materials and components, power to operate machinery and
piece rate payments to employees.
5 $800
6 $8,000
7 a $1,000 b $8,200
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Bears produced Total fixed costs Total variable Total costs Average cost per
per week $ costs $ $ bear $

0 200 0 200 -
50 200 400 600 12.00
100 200 800 1,000 10.00
200 200 1,600 1,800 9.00
300 200 2,400 2,600 8.67
400 200 3,200 3,400 8.50
500 200 4,000 4,200 8.40
600 200 4,800 5,000 8.33
700 200 5,600 5,800 8.29
800 200 6,400 6,600 8.25
900 200 7,200 7,400 8.22
1000 200 8,000 8,200 8.20

$
9000

8000 Total fixed costs

Total variable costs
7000
Total costs
6000

5000

4000

3000

2000

1000

0 100 200 300 400 500 600 700 800 900 1000
Output of bears per week

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 Unit 4 The private firm as producer and employer

10 $10
11 $10
12 $1,000
13 $10,000
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Bears produced and Total revenue $ Total costs $ Profit or loss $

sold per week
0 0 200 -200
50 500 600 -100
100 1,000 1,000 0
200 2,000 1,800 200
300 3,000 2,600 400
400 4,000 3,400 600
500 5,000 4,200 800
600 6,000 5,000 1,000
700 7,000 5,800 1,200
800 8,000 6,600 1,400
900 9,000 7,400 1,600
1,000 10,000 8,200 1,800

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$
12000

Total fixed costs

10000 Total variable costs
Total costs Profit
Total revenue
8000

6000

4000
Loss

2000

0 100 200 300 400 500 600 700 800 900 1000
Output of bears per week

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 Unit 4 The private firm as producer and employer

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12

10
Average cost per bear $

0 100 200 300 400 500 600 700 800 900 1000
Output of bears per week

Activity 4.12 A calculated issue

1
Magazines per Total fixed costs Total variable Total cost Average cost Total Revenue Profit or Loss
month costs
0 $4,000 0 $4,000 - 0 - $4,000
1,000 $4,000 $3,000 $7,000 7.00 $5,000 -$2,000
2,000 $4,000 $6,000 $10,000 5.00 $10,000 0
3,000 $4,000 $9,000 $13,000 4.33 $15,000 $2,000
4,000 $4,000 $12,000 $16,000 4.00 $20,000 $4,000
5,000 $4,000 $15,000 $19,000 3.80 $25,000 $6,000
6,000 $4,000 $18,000 $22,000 3.67 $30,000 $8,000
7,000 $4,000 $21,000 $25,000 3.57 $35,000 $10,000
8,000 $4,000 $24,000 $28,000 3.50 $40,000 $12,000

2 2,000 magazines per month

3

$
45000
40000 Total cost
Total revenue
35000
30000 Profit

25000
20000
15000 Loss

10000
5000

0 1000 2000 3000 4000 5000 6000 7000 8000

Output of magazines per month

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 Unit 4 The private firm as producer and employer

Activity 4.13 Size matters

• The largest firm depends on the measure used. Toyota is the largest employer.
Exxon-Mobil is the largest by capital employed and value of total annual
output. Google has the largest market share of the four companies.
• As the answer to the first question illustrates, it is not sensible to use just one
measure of firms’ size.
• Focusing on just one measure ignores other measures of firms’ size. For
example, labour-intensive firms may have very little capital employed.
High-tech manufacturing firms may employ many billions of dollars worth
of capital equipment on automated production lines that require very little
labour input. Similarly, a small village shop may have a large market share of
its local market because it is the only shop for many miles, but a large global
retailer may have a smaller share of a huge global market worth many billions
of dollars.

Activity 4.14 What type of integration?

Merger or takeover Horizontal? Vertical? Lateral?
A chocolate maker takes over a cocoa plantation ✔
A travel insurer merges with a on-line holiday company ✔
A clothing retailer takes over a clothes manufacturer ✔
A bus manufacturer merges with a car maker ✔
An investment bank takes over an electronics producer ✔
An aircraft maker merges with an aero-engine company ✔

Activity 4.15 Is big beautiful?

Case 1: Cleaning up their act
1,2 Larger firms tend to be more secure financially and banks are therefore more
willing to extend loans to them and at more attractive interest rates than they
would for smaller firms (financial economies); the fixed costs of new, more
efficient machinery and advertising can be spread over a much larger output
in a large firm (technical and marketing economies); larger firm produces a
range of soaps for different markets (risk-bearing economies)

Case 2: Blasting off!

1,2 The large firm was able to invest in large-scale blast furnace – the fixed cost
can be spread over a much larger output than smaller firms investing in
furnaces (technical economies); large firms are also able to invest in their
own vehicle fleet rather than using the services of road haulage providers and
paying the cost of their services and profit margins (technical economies);
large firms are able to buy in bulk from suppliers and receive discount
(purchasing economies); large firms are able to access new markets overseas
(risk-bearing economies).

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 Unit 4 The private firm as producer and employer

Activity 4.16 Chewing over a problem

All three firms have doubled all their inputs but only the Ace Company more
than doubled its outputs from 10,000 to 25,000 boxes of sweets per year. The
productivity of resources has therefore increased at Ace.
In contrast, the productivity of resources is unchanged at the Crikey Company.
Doubling its inputs has doubled outputs. However, productivity has fallen at the
Boom Company. Output has increased by only 67% – from 12,000 to 20,000
boxes per year – despite the 100% increase in its resource inputs.

Activity 4.17 Chewing it over some more

Average cost per box of sweets in year 2 are as follows:
Ace company : $0.80 (average cost has fallen)
Boom company : $1.20 (average cost has risen)
Crikey company : $1.00 (average cost is constant).

Activity 4.18 Staying small

Personal preference; the owner of a sole trader keeps all the profits; there is
preferential tax treatment of small firms to encourage enterprise; they lack
access to capital; they are able to work from home; there has been a fall in cost
of new technology; customers are attracted by more personalized service; the
market size is small.

Activity 4.19 All washed up

1 Price wars involve competing firms continually trying to undercut each
other’s prices, often to force rivals out of business. All firms involved in a price
war usually end up losing money by trying to out compete each other on
price.
2 P&G’s motives were recent price cuts and an aggressive new advertising
campaign for its main rival brand.
3 Profit margins fell.
4 HUL may have significant economies of scale. This means its average or unit
costs are likely to be lower than its rival. It can therefore afford to lower prices
and still earn a good margin for profit. Having a bigger range of well-known
products in its portfolio also means it will only have to cut the prices of those
that compete directly with those products offered by P&G, while having a
bigger market share also means it has more customers, many of whom may
be loyal to brands offered by HUL and therefore unlikely to switch easily to
rival products. It will also have a larger share of total sales revenue. This will
give the company greater financial strength to withstand a price war.
5 It is price elastic, because there are many close substitutes to choose from.
6 Price leadership could have been used to avoid a price war. Instead HUL and
P&G could charge very similar prices and could raise them or lower them
together at the same time to avoid price competition.

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 Unit 4 The private firm as producer and employer

Activity 4.20 Market concentrations

1 The most concentrated industries were sugar and tobacco; the least
concentrated were plastic products, and metal forging and pressing.
2 Many industries are near monopolies (for example sugar, tobacco and gas
distribution) or oligopolies with just a small number of large firms controlling
the total market supply. Non-price competition may be more important in
these industries. Price and non-price competition may be more aggressively
pursued in the least concentrated industries.
3 Other useful information to assess the degree of market competition will
include: the degree of competition from overseas producers; the prices of
similar products charged by the main suppliers; the stability of variability of
prices over time; the degree of non-price competition; and the stability of
market shares over time.

Activity 4.21 Creating barriers

Big Sell Supermarket plc: barriers might include the scale of the supermarket itself
and the product ranges it offers to customers allowing them the convenience of
shopping for many of the products they need and want ‘under one roof’; it could
prevent its wholesaler from supplying rival retailers by threatening to take its
custom elsewhere if the wholesaler does.
Flyhigh airlines: the airline may use predatory pricing to deter new competition
and heavily subsidize those routes under threat from competition with monopoly
profits from other routes.
Spreadwell Limited: it can threaten to withhold supplies of its popular margarine
from supermarkets that stock rival products.

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