Firms | O Level Economics 2281 & IGCSE Economics 0455 | Detailed Free Notes To Score An A Star (A*)
3.5.1 Classification of Firms
Firms can be classified based on:
A. Sector of the Economy
- Primary Sector: Firms engaged in extraction of natural resources (e.g., farming, fishing, mining).
- Secondary Sector: Firms involved in manufacturing and construction (e.g., car manufacturers, textile factories).
- Tertiary Sector: Firms providing services (e.g., banks, schools, retailers).
B. Ownership Structure
- Private Sector Firms: Owned and run by individuals or groups for profit.
- Sole traders, partnerships, companies.
- Public Sector Firms: Owned and operated by the government to provide public goods and services.
- Examples: utility companies, public transport.
C. Size of Firms
- Small Firms: Employ few workers, low revenue/output.
- Large Firms: Employ many workers, operate at large scale, high output and market reach.
3.5.2 Small Firms
Advantages of Small Firms
- Flexibility: Can quickly adapt to market changes.
- Closer Customer Relationships: Personalized services build loyalty.
- Lower Costs: Low overheads, simpler operations.
- Niche Markets: Can serve specialized segments ignored by large firms.
- Ease of Control: Simple management and fewer employees.
Disadvantages of Small Firms
- Limited Capital: Struggle to secure large-scale finance.
- Lack of Economies of Scale: Higher average costs.
- Limited Research and Development (R&D): Fewer resources for innovation.
- Vulnerability: More likely to fail in recessions or due to strong competition.
- Restricted Market Access: May not export or scale easily.
Challenges Facing Small Firms
- High competition from larger firms.
- Difficulty accessing loans or investment.
- Regulatory burdens and tax compliance.
- Difficulty attracting skilled labor.
Reasons for Their Existence
- Low barriers to entry in some industries.
- Provide employment and local services.
- Serve small/niche markets.
- Lifestyle choice for some owners (e.g., family-run businesses).
3.5.3 Causes and Forms of the Growth of Firms
Internal Growth (Organic Growth)
- Definition: Expansion using firm’s own resources.
- Methods:
- Opening new branches or outlets.
- Increasing production capacity.
- Investing in marketing or innovation.
- Advantages:
- Controlled and less risky.
- Maintains culture and values.
- Disadvantages:
- Slow growth rate.
- Limited by internal resources.
External Growth
- Definition: Growth through mergers or acquisitions (buying other firms).
- Faster but often riskier than internal growth.
3.5.4 Mergers
Types of Mergers
| Type | Definition | Example | Advantages | Disadvantages |
|---|---|---|---|---|
| Horizontal | Same industry & stage of production | Coke + Pepsi | Economies of scale, reduced competition | Monopoly risk, culture clash |
| Vertical | Same industry but different stage (forward or backward) | Car maker buys tyre supplier | Control supply chain, cost savings | Less focus, over-integration |
| Conglomerate | Different industries | Amazon + Whole Foods | Risk diversification, entry into new markets | No expertise, management complexity |
3.5.5 Economies and Diseconomies of Scale
A. Economies of Scale
As a firm increases output, average cost per unit falls due to efficiency gains.
Internal Economies of Scale (within the firm):
- Purchasing: Bulk buying = discounts.
- Managerial: Specialized staff → efficiency.
- Technical: Use of advanced machinery.
- Marketing: Advertising costs spread over more units.
- Financial: Easier access to loans at lower interest.
- Risk-bearing: Product and market diversification.
External Economies of Scale (outside the firm):
- Skilled Labour Pool: Industry concentration attracts talent.
- Infrastructure: Improved transport, utilities.
- Supplier Networks: Proximity to component suppliers.
- Knowledge Spillover: Innovations and ideas shared.
B. Diseconomies of Scale
Beyond a certain size, average cost per unit increases due to inefficiencies.
Types of Diseconomies:
| Type | Description |
|---|---|
| Managerial | Too many layers of management → poor communication. |
| Motivational | Workers feel isolated in large firms → lower productivity. |
| Coordination | Difficult to coordinate across departments or global operations. |
Impact on Firms/Industry
- Smaller firms: Can operate efficiently within certain size limits.
- Larger firms: Must balance scale with efficiency or face rising costs.
- Industry becomes more concentrated as large firms dominate.
Exam Tip
- Know clear distinctions: internal vs external growth, horizontal vs vertical vs conglomerate mergers.
- Use examples from real companies.
- Diagrams:
- U-shaped average cost curve to show economies and diseconomies.
- Discuss realistic trade-offs:
- Growth vs control,
- Scale vs flexibility.
