Chapter 20 – Firms

Industry – group of firms producing the same product

Primary sector – first stage of production, collection of raw materials
Secondary sector – involved with the processing of raw materials into semi/finished goods
Tertiary sector – industries producing services
Quaternary sector – service industries that are knowledge based (information technology)

The size of firms

Age of the firms – firms start small, may take some time to grow in size
Availability of financial capital – more it can draw to fund expansion, more capable to grow
Type of business organisation – MNC is larger than a business that is run by one person
Internal economies of scale – lower average costs, lower price, high market share.
Size of the market – large demand for product, possible for firm to grow large

Small firms
Small size of the market

Preference of customers – for personal services consumers may prefer small firms. Can
provide a friendlier personal experience and cater to individual needs

Owner’s preference – may want to remain small to avoid stress of large firm also expanding
firm may lead to loss of control

Flexibility – small firms can respond to change in the market conditions quicker. They are
more likely to pick up on changes in demand due to touch with customers. They can take
decisions quicker

Lack of financial capital – lack of capital and money to expand

Specialisation – small firms can provide customised products

Government support – may provide financial help to small firms. They provide employment,
can develop skills of workers, and can have potential to grow into larger firms

Technical factors – where no capital is needed, more firms will be set up (less barriers to
entry/exit)

Causes of growth
Internal growth – an increase in the size of a firm resulting in enlarging existing plants or
opening new ones

External growth – increase in the size of firm resulting from or merging or taking over
another firm
Mergers
Horizontal merger – merger of firms producing the same product
Increases market share, a direct competitor is eliminated. It also removes unnecessary
equipment and plant to make a firm more efficient. Can save on managerial staff. They may
experience diseconomies of scale. Large firm may be difficult to control. May be difficult to
integrate if they had different working styles

Vertical merger – merger with firm that provides an outlet or supplies raw materials
Backwards – earlier stage of production (with supplier of raw materials) to ensure adequate
supply of raw materials and at reasonable prices or may restrict access for rival firms
Forwards – later stage of production (with outlet of sale of products) to ensure sufficient
outlets and products sold at high quality outlets

Conglomerate merger – a merger between firms producing different products (to diversify)

Effect of merger on consumers

If it leads to economies of scale, consumers can experience lower prices and they can get
higher quality and more innovation, if the merged firms get more efficient. May also result in
diseconomies of scale. In the case of a horizontal merger, it can reduce choice and market
power can be abused and goods can be priced higher due to higher market share and power

Economies and diseconomies of scale

Internal economies of scale – Lower long run average cost resulting from firm growing

Types of internal economies of scale

Buying economies – large firms that buy in bulk can receive discounts, lowering the cost

Selling economies – more goods sold can reduce average COP, cost of transporting 40 goods
is less per good than that of 4 goods. Advertising cost can be spread over so many goods

Managerial economies – can afford to employ specialist staff as they can spread their pay
over high output, this can increase firms’ efficiency, reduce COP and raise demand/revenue

Labour economies – they can engage in division of labour

Financial economies – find it easier and cheaper to raise finance. Banks are more willing to
lend to large firms as they are more trusted, have more valuable to offer. Banks charge large
borrowers less, per $ borrowed. Large firms can also sell shared to raise money

Technical economies – larger output, the more viable becomes to use large technologically
advanced machinery

Research and development economies – large firms can have a department for this, the
department can reduce average costs by developing more efficient methods of production

Risk bearing economies – produce a range of products. If profitability of one product

increases, a firm can devote its resources towards that
Internal diseconomies of scale – higher long run average cost resulting from firm growing

Types of internal diseconomies of scale

Difficulties controlling the firm – can be hard managing a large firm. Firm becomes slower in
responding in market changes. Number of layers of management can slow down decision
making

Communication problems – may not get the opportunity to effectively communicate to

management team. Difficult to ensure everyone in the firm has knowledge about duties etc

Poor industrial relations – greater risk of lack of motivation of workers, strikes, and other
industrial action. Workers have less sense of belonging, more conflicts due to presence of so
many opinions

External economies of scale – lower long run average costs resulting from industry growing

Types of external economies of scale

Skilled labour force – firm can recruit workers who have been trained by other firms

Good reputation – area can gain good reputation for high quality production (Bordeaux is
famous for wine production)

Specialist suppliers of raw materials and capital goods – when industry becomes large, it can
become worthwhile to set up providing for the needs of that industry

Specialist services – colleges may have courses pertaining to that particular industry

Specialist markets – large industries have specialist selling places

Improved infrastructure – growth of an industry may encourage governments to provide

better road links and electricity supplies