Theme 3: Business Behaviour and the labour market
3. 1. 1. Size and types of firms
a. Reasons for large and small firms
- Large firms exist because of e.o.s, natural monopolies and barriers to entry.
- Firms want to grow to obtain more e.o.s, gain monopoly power and for > security.
- There are small firms because of constraints on growth: size of market, access to
finance, owner objectives and regulation. Not all firms want to grow.
By growing, a firm will:
● Gain e.o.s -> ↓ cost of prod. + sell more -> more revenue = more
profit
● Gain market share -> ability to influence prices + restrict entry of
other firms -> helps with profits in the LR. Can also mean monopsony
power -> ↓ cost by ↓prices of resources
, ● Gain security as they build up their assets and cash which can be used in financial
difficulties. Are also more likely to diversify and have a range of goods in various
markets, so they are less vulnerable to changes and difficulties.
b. Ownership vs. control (principal-agent problem)
In large firms, there can be a separation of control from ownership:
- Firms are owned by shareholders -> have no control over day-to-day running
- Chief executive and senior management do this
- Shareholders are represented by the Board of Directors who they can vote on or
off
Problems can arise as the different stakeholders can have different aims:
- The owner will want to maximise the returns on their investment and SR profit
maximise
- However, directors and managers will want to maximise their own benefits
This is the principal-agent problem, where one group, the agent, makes decisions for the
principal. The agent should maximise the principal’s benefits but they can be tempted to
maximise their own benefits. Because of this, many firms profit satisfice rather than profit
maximise. This problem could be overcome by relating the manager’s bonuses to profits or to
giving them shares, in this way they will benefit from higher profits.
c. Public vs private sector organisations
Private sector: owned by individuals or companies (not the state), includes sole traders and
PLCs.
- Aim: profit maximisation (or satisfaction).
- There are some not-for-profit organisations
Public sector: owned and controlled by the government.
- Aim: provide services
- Profits aren’t main aim, can make a loss
d. Profit vs not-for-profit organisations
The private sector can be split into for profit and not-for-profit organisations:
- Almost all private sector organisations are run to make a profit and to maximise the
financial benefits for their shareholders. They may not necessarily profit-maximise,
but their long term goal is to make money.
- Some private sector organisations are not-for-profit. Any profit they do make is used to
support their aim of maximising social welfare and helping individuals and groups.
These organisations include charities and smaller organisations who aren’t large
enough to be classified as charities.
,3. 1. 2. Business growth
Reasons for growth
● Large companies →e.o.s
● Control over the market →can ↓competition
● ↓ risks →some markets are fragile and could suffer from changes in D
during recessions. Could decide to diversify to ↓ uncertainty
● The divorce of ownership from control, a firm may justify ↑ wages and
bonuses to managers at the expense of shareholders
● Build security →build up more assets and cash to use in difficult
times
● Access to new markets/resources/patents
● Protection from unwanted predators/hostile takeovers
Reasons to stay small
● Owner objectives
● Size of the market
● Access to finance
● Regulation
● Avoid dise.o.s
● Principal agent problem, x-inefficiency, satisficing behaviour
● Avoid dilution of shareholder value
a. How businesses grow + b. Advantages and disadvantages
● Organic growth:
Growth by increasing output, e.g. investment or more labour. Can open new shops or offer
new products.
Advantage Disadvantages
Cheaper and lower risk than integration Sometimes firms are unable to grow
organically because of market size...
Can stay in control of business May be slow for directors who want to
maximise their salaries
Difficult to develop new products
● Forward and backward vertical integration
- Integration: growth through amalgamation, mergers or takeovers.
, - Merger or amalgamation: two or more firms join under common ownership
- Takeover: one firm buys another
- vertical integration: integration of firms in the same industry but different stages in the
different
- Forward integration: supplier mergers with buyer
- backward integration: buyer buys the supplier
Advantage Disadvantages
Increased potential for profit as the firm Firms may have no expertise in their new
takes potential profit from a large part of the industry
chain of production
Less risk as suppliers don't worry about
buyers not buying or buyers about suppliers
not supplying
Backward integration means businesses can
control the quality of supplies and ensure
good delivery
Don't have to worry about being charged
high prices, helps keep costs low
Forward integration ensures retail outlets
and can restrict these for competitors
● Horizontal integration
Firms in the same industry at the same stage of production integrate
Advantage Disadvantages
Reduces competition, increases market share Increase risk if the industry fails, they have
-> more power to influence market nothing to fall back on and will have invested
a lot of money
Firms can specialise and rationalise, reducing
areas where they are duplicated
Can grow in an area where they already have
some expertise -> higher chances of success
● Conglomerate integration
Firms in different industries with no apparent relations integrate. Can sometimes be connected
through some common raw materials/technology/outlets.
3. 1. 1. Size and types of firms
a. Reasons for large and small firms
- Large firms exist because of e.o.s, natural monopolies and barriers to entry.
- Firms want to grow to obtain more e.o.s, gain monopoly power and for > security.
- There are small firms because of constraints on growth: size of market, access to
finance, owner objectives and regulation. Not all firms want to grow.
By growing, a firm will:
● Gain e.o.s -> ↓ cost of prod. + sell more -> more revenue = more
profit
● Gain market share -> ability to influence prices + restrict entry of
other firms -> helps with profits in the LR. Can also mean monopsony
power -> ↓ cost by ↓prices of resources
, ● Gain security as they build up their assets and cash which can be used in financial
difficulties. Are also more likely to diversify and have a range of goods in various
markets, so they are less vulnerable to changes and difficulties.
b. Ownership vs. control (principal-agent problem)
In large firms, there can be a separation of control from ownership:
- Firms are owned by shareholders -> have no control over day-to-day running
- Chief executive and senior management do this
- Shareholders are represented by the Board of Directors who they can vote on or
off
Problems can arise as the different stakeholders can have different aims:
- The owner will want to maximise the returns on their investment and SR profit
maximise
- However, directors and managers will want to maximise their own benefits
This is the principal-agent problem, where one group, the agent, makes decisions for the
principal. The agent should maximise the principal’s benefits but they can be tempted to
maximise their own benefits. Because of this, many firms profit satisfice rather than profit
maximise. This problem could be overcome by relating the manager’s bonuses to profits or to
giving them shares, in this way they will benefit from higher profits.
c. Public vs private sector organisations
Private sector: owned by individuals or companies (not the state), includes sole traders and
PLCs.
- Aim: profit maximisation (or satisfaction).
- There are some not-for-profit organisations
Public sector: owned and controlled by the government.
- Aim: provide services
- Profits aren’t main aim, can make a loss
d. Profit vs not-for-profit organisations
The private sector can be split into for profit and not-for-profit organisations:
- Almost all private sector organisations are run to make a profit and to maximise the
financial benefits for their shareholders. They may not necessarily profit-maximise,
but their long term goal is to make money.
- Some private sector organisations are not-for-profit. Any profit they do make is used to
support their aim of maximising social welfare and helping individuals and groups.
These organisations include charities and smaller organisations who aren’t large
enough to be classified as charities.
,3. 1. 2. Business growth
Reasons for growth
● Large companies →e.o.s
● Control over the market →can ↓competition
● ↓ risks →some markets are fragile and could suffer from changes in D
during recessions. Could decide to diversify to ↓ uncertainty
● The divorce of ownership from control, a firm may justify ↑ wages and
bonuses to managers at the expense of shareholders
● Build security →build up more assets and cash to use in difficult
times
● Access to new markets/resources/patents
● Protection from unwanted predators/hostile takeovers
Reasons to stay small
● Owner objectives
● Size of the market
● Access to finance
● Regulation
● Avoid dise.o.s
● Principal agent problem, x-inefficiency, satisficing behaviour
● Avoid dilution of shareholder value
a. How businesses grow + b. Advantages and disadvantages
● Organic growth:
Growth by increasing output, e.g. investment or more labour. Can open new shops or offer
new products.
Advantage Disadvantages
Cheaper and lower risk than integration Sometimes firms are unable to grow
organically because of market size...
Can stay in control of business May be slow for directors who want to
maximise their salaries
Difficult to develop new products
● Forward and backward vertical integration
- Integration: growth through amalgamation, mergers or takeovers.
, - Merger or amalgamation: two or more firms join under common ownership
- Takeover: one firm buys another
- vertical integration: integration of firms in the same industry but different stages in the
different
- Forward integration: supplier mergers with buyer
- backward integration: buyer buys the supplier
Advantage Disadvantages
Increased potential for profit as the firm Firms may have no expertise in their new
takes potential profit from a large part of the industry
chain of production
Less risk as suppliers don't worry about
buyers not buying or buyers about suppliers
not supplying
Backward integration means businesses can
control the quality of supplies and ensure
good delivery
Don't have to worry about being charged
high prices, helps keep costs low
Forward integration ensures retail outlets
and can restrict these for competitors
● Horizontal integration
Firms in the same industry at the same stage of production integrate
Advantage Disadvantages
Reduces competition, increases market share Increase risk if the industry fails, they have
-> more power to influence market nothing to fall back on and will have invested
a lot of money
Firms can specialise and rationalise, reducing
areas where they are duplicated
Can grow in an area where they already have
some expertise -> higher chances of success
● Conglomerate integration
Firms in different industries with no apparent relations integrate. Can sometimes be connected
through some common raw materials/technology/outlets.
