Business Growth (3.1)
Size and Types of Firms
Why do some firms remain small and why do some grow?
Large firms exist for 2 reasons;
• Economies of scale
• Barriers to entry may exist which protect large firms
Small firms survive because
• Economies of scale are small relative to market size
o Small firms can take advantage of diseconomies of scale by the larger firms
o Changing technology helps small firms the same cost advantage as the large
firms in reaching out to customers
• Cost of production for large firms might be higher than small firms
o Productive inefficiency caused by large firms – some unorganised
o Large firms have to pay higher wages because of formal markets – small
companies could pay low rates
• Barriers to entry might be low
o Cost of setting up in grocery/newsagent market might be small
• Small firms can be monopolists
o Newsagent might have monopoly in local area
o Consumers can’t be bothered to walk extra distance – opportunity cost
o Can satisfy total demand and charge whatever price when product is unique
and limited amount of firms in the market
Divorce of ownership from control – principle agent problem
• Smaller firms- owner runs it day to day
• Larger firms place control to directors and managers to run business
• In large companies there is a divorce of ownership from control
• Board of directors include a chair of the board and a chief executive
o Chief executive and senior managers are in control of the decision making
This is an example of the principle agent problem
• Agent makes decisions on behalf of other group – agent always wants to maximise
own benefit instead of group (shareholders) running it
o Award themselves large bonuses and pay packages
• Want to grow the company for own benefit but at expense of profit
Public Sector and Private Sector organisations
• Public sector organisations – organisations controlled by the state – purpose is to
provide a service to the UK citizen. E.g. NHS
• Private sector organisations are owned by individuals and all want to make profit
(Profit organisations)
• Non for profit organisations are organisation that do not have profit as the main goal
– use profit to support aims e.g. charities
, Business Growth
How do they Explanation Advantages Disadvantages
grow?
Organic Growth through • Low Risk • Slow to see results
Growth success and • Not as expensive as merger • FDI cannot be done by
reinvestment of organic growth
profits
Forward Merger with firm • Cut out ‘middle men’ and • Expensive
vertical in same industry capture profits • Little experience in
Integration and LATER stage of • Cost savings industry – imperfect
production (Closer knowledge
to consumer)
Backward Merger with firm • Cut out ‘middle men’ and • Expensive
vertical in same industry capture profits • Little experience in
Integration and EARLIER stage • Control of inputs (Dessert industry – imperfect
of production lounge controls milk supplies) knowledge
(Closer to raw • Cost savings – more efficient
materials) with more suppliers
Horizontal Mergers with firm • Increase market share in one • Expensive
Integration in same industry product resulting in market • Mergers are managed
and same stage of share poorly
production • Able to set prices higher due
to more control over market
• Reduce average cost leading
to economies of scale
• Reduce competition
Conglomerate Merger of 2 firms • Reduces risk as not • Asset stripping has
Integration with no common dependent on one market negative effects on
interests • Asset stripping – price of workers, customers and
assets is worth more than the local economies – lost
company which can make jobs and derelict
profits industrial sights
• Poorly managed
• No expertise in market
they are dealing with
Constraints on Business growth
• Size of the market
o Markets vary in size – local markets are small and different demand for
different products
• Access to finance
o Firms need access to finance to expand
o Firms use profits & sometimes loans – depends on willingness always a risk
• Owner objectives
o Not every owner wants to grow – benefits of staying small
o Does not want extra work / extra risk with expansion
, • Regulation
o Government regulation can be important
o Pharmacies in UK can only expand by buying another Pharmacy
Demergers
Reasons for Demergers
Demergers occur when a firm splits into 2 or more separate parts to create 2 or more equal
firms
• Lack of synergies
o One part of the firm has no impact on more efficient and profitable running
of the other part of the firm
o Could lead to diseconomies of scale – businesses managers have to divide
time and not done effectively as one part is inefficient
• Price
o Price of a firm can be worth more as 2 separate companies due to worth
being based off growth predictions
• Focussed companies
o Argument that management can deliver higher profits and growth by
focussing on a limited range of markets
Impact of Demergers on;
Businesses
• Increased specialisation results to greater efficiency
• Helps survive greater competition
Workers
• Senior managers may gain promotion – 2 of each job now
• Some lose jobs – if new firm is more efficient – job loss is common
Consumers
• Benefit if become more efficient – lower cost = lower price
, Business Objectives (3.2)
Control
Firm motivations are answered by who controls decision making. These people are;
• Owners or Shareholders –
o Majority shareholders or owners make decisions
• Directors and managers –
o Directors look after shareholder interests
o Directors usually appoint managers – divorce between ownership and control
• Workers
o Influence on matters such as wages, location etc.
• The state
o Taxes, consumer protection, health and safety may force companies to act in
a different way
• Consumer
o Can pressure companies to make them change policies
o If they don’t buy – firms don’t make profits
Profit Maximisation
Short Run
• Shareholders want to maximise their gain – goal of firms is to profit maximise
• MR=MC to equate levels of production
• SR firms will supply if price is above AVC
• LR will supply only if meets AC
• Profit maximisation occurs when TR-TC is the greatest
Long Run
• Non-Keynesian economists believe firms maximise profits in LR
• SR Profit Max means firms will adjust price and output in response to changes in
market
o However, rapid changes might affect position in market – consumers view
this as a sign of profiteering and switch to other brands
o Price changes also cause costs – menu costs etc.
Divorce of ownership from control
• In large businesses – owners appoint directors and managers to run on their behalf
• Owners want to profit maximise – directors and managers want to maximise their
own benefit
o Includes their own pay and bonuses
• Profit maximising remains important – they need to remain in profit – if loss the firm
shut down, if doing poorly –takeover is possible
o Directors and managers need to make good enough profit to satisfy owner
• This is called profit satisficing – firm aims to make minimum accepted level of profit
and then pursue other aims
,Revenue Maximisation
• Uses the theory of divorce of ownership from control – objective of managers is to
maximise total revenue for the firm
• TR maximised when MR =0
• Minimum level of profit accepted is normal profit – more profit can be made if profit
maximising was its objective
• Oligopolistic firms make abnormal profits in LR
o Not applicable to perfect competition or monopolistic competition
Sales Maximisation
• Maximise sales volumes – managers can also justify rewards by pointing to sales
• AC=AR is where sales is maximised (Normal profits are made at this point)
o Increasing sales beyond this will lead to a loss which will not satisfy sales
maximisation
, Revenues, Costs and Profits (3.3)
Revenue
Total Revenue (TR) is the amount of money a firm receives from sales over a certain period
of time
• TR= Price x Quantity
Average Revenue (AR) is the revenue per unit sold (Price – demand curve)
• AR = TR/Q = price
Marginal Revenue (MR) is the addition to revenue of producing one extra unit
• MR = Change in TR/ Change in Q
Revenue Curves
When price is constant – (Demand is elastic) – MR = AR = D
• £5 price – if sell 3 for £15 and 1 for £5
o MR is £5 and AR £5
When price is constant – Total revenue is upward sloping as sales increase
(TR increases by 5 as output increases by 1)
When a firm has to lower price to achieve higher sales, the price of the next additional unit
will be less and less.
• MR will be downward sloping (2x as steep as AR
curve)
• AR will also fall
Revenue and Price Elasticity
• When price is constant, AR and MR are horizontal,
hence demand is perfectly elastic
• As price falls, when total revenue is still increasing,
demand is price elastic as a FALL in price still leads to
INCREASED revenue
• When total revenue falls, demand is price inelastic as
a fall in price leads to a fall in total revenue
, Production
Short Run and Long Run
• Short run – Some factor inputs are fixed in supply – usually fixed capital
o Firm could, employ more workers and use more raw materials BUT space is
limited and cannot be changed in the short run
• Long run – all factor inputs are variable – producer can vary amount of labour, land
and capital if they want
o Firm could move to a bigger factory, employ more workers and use more raw
materials
The Short Run: Diminishing Returns
• Short run, at least one factor is fixed – if a firm uses capital and labour, only labour
can be varied
• Output would initially rise the more workers you employ
• However, there is an optimum level of production which is productively efficient
o 10,000 workers in a factory designed for 500 people – not efficient
• This is the Law of Diminishing Returns or Law of Diminishing Marginal Productivity
Total, average and marginal products
• Total Product is the quantity of output by given number of input
over period of time
• Average Product is the quantity of output per unit input
• Marginal Product is the addition to output produced by an extra unit
of input
• Initially marginal product rises but 5th procures less than 4th.
o Diminishing Marginal Returns applies between worker 4 and
5
o Diminishing average returns set in between 6 and 7
The Long Run: Returns to scale
• Law of Diminishing Returns assume firms operate in the short run
• In Long Run, firms can vary all their factor inputs
• Increasing Returns to Scale
o Equal percentage increase in inputs to production leads to a greater
proportionate increase in output
o If all Inputs double but output trebles – increasing returns to scale occurs
• Constant Returns to Scale
o Equal percentage increase in inputs to production leads to the same
percentage increase in output
• Decreasing returns to scale
o Equal percentage increase in inputs to production leads to a greater
proportionate fall in output
Size and Types of Firms
Why do some firms remain small and why do some grow?
Large firms exist for 2 reasons;
• Economies of scale
• Barriers to entry may exist which protect large firms
Small firms survive because
• Economies of scale are small relative to market size
o Small firms can take advantage of diseconomies of scale by the larger firms
o Changing technology helps small firms the same cost advantage as the large
firms in reaching out to customers
• Cost of production for large firms might be higher than small firms
o Productive inefficiency caused by large firms – some unorganised
o Large firms have to pay higher wages because of formal markets – small
companies could pay low rates
• Barriers to entry might be low
o Cost of setting up in grocery/newsagent market might be small
• Small firms can be monopolists
o Newsagent might have monopoly in local area
o Consumers can’t be bothered to walk extra distance – opportunity cost
o Can satisfy total demand and charge whatever price when product is unique
and limited amount of firms in the market
Divorce of ownership from control – principle agent problem
• Smaller firms- owner runs it day to day
• Larger firms place control to directors and managers to run business
• In large companies there is a divorce of ownership from control
• Board of directors include a chair of the board and a chief executive
o Chief executive and senior managers are in control of the decision making
This is an example of the principle agent problem
• Agent makes decisions on behalf of other group – agent always wants to maximise
own benefit instead of group (shareholders) running it
o Award themselves large bonuses and pay packages
• Want to grow the company for own benefit but at expense of profit
Public Sector and Private Sector organisations
• Public sector organisations – organisations controlled by the state – purpose is to
provide a service to the UK citizen. E.g. NHS
• Private sector organisations are owned by individuals and all want to make profit
(Profit organisations)
• Non for profit organisations are organisation that do not have profit as the main goal
– use profit to support aims e.g. charities
, Business Growth
How do they Explanation Advantages Disadvantages
grow?
Organic Growth through • Low Risk • Slow to see results
Growth success and • Not as expensive as merger • FDI cannot be done by
reinvestment of organic growth
profits
Forward Merger with firm • Cut out ‘middle men’ and • Expensive
vertical in same industry capture profits • Little experience in
Integration and LATER stage of • Cost savings industry – imperfect
production (Closer knowledge
to consumer)
Backward Merger with firm • Cut out ‘middle men’ and • Expensive
vertical in same industry capture profits • Little experience in
Integration and EARLIER stage • Control of inputs (Dessert industry – imperfect
of production lounge controls milk supplies) knowledge
(Closer to raw • Cost savings – more efficient
materials) with more suppliers
Horizontal Mergers with firm • Increase market share in one • Expensive
Integration in same industry product resulting in market • Mergers are managed
and same stage of share poorly
production • Able to set prices higher due
to more control over market
• Reduce average cost leading
to economies of scale
• Reduce competition
Conglomerate Merger of 2 firms • Reduces risk as not • Asset stripping has
Integration with no common dependent on one market negative effects on
interests • Asset stripping – price of workers, customers and
assets is worth more than the local economies – lost
company which can make jobs and derelict
profits industrial sights
• Poorly managed
• No expertise in market
they are dealing with
Constraints on Business growth
• Size of the market
o Markets vary in size – local markets are small and different demand for
different products
• Access to finance
o Firms need access to finance to expand
o Firms use profits & sometimes loans – depends on willingness always a risk
• Owner objectives
o Not every owner wants to grow – benefits of staying small
o Does not want extra work / extra risk with expansion
, • Regulation
o Government regulation can be important
o Pharmacies in UK can only expand by buying another Pharmacy
Demergers
Reasons for Demergers
Demergers occur when a firm splits into 2 or more separate parts to create 2 or more equal
firms
• Lack of synergies
o One part of the firm has no impact on more efficient and profitable running
of the other part of the firm
o Could lead to diseconomies of scale – businesses managers have to divide
time and not done effectively as one part is inefficient
• Price
o Price of a firm can be worth more as 2 separate companies due to worth
being based off growth predictions
• Focussed companies
o Argument that management can deliver higher profits and growth by
focussing on a limited range of markets
Impact of Demergers on;
Businesses
• Increased specialisation results to greater efficiency
• Helps survive greater competition
Workers
• Senior managers may gain promotion – 2 of each job now
• Some lose jobs – if new firm is more efficient – job loss is common
Consumers
• Benefit if become more efficient – lower cost = lower price
, Business Objectives (3.2)
Control
Firm motivations are answered by who controls decision making. These people are;
• Owners or Shareholders –
o Majority shareholders or owners make decisions
• Directors and managers –
o Directors look after shareholder interests
o Directors usually appoint managers – divorce between ownership and control
• Workers
o Influence on matters such as wages, location etc.
• The state
o Taxes, consumer protection, health and safety may force companies to act in
a different way
• Consumer
o Can pressure companies to make them change policies
o If they don’t buy – firms don’t make profits
Profit Maximisation
Short Run
• Shareholders want to maximise their gain – goal of firms is to profit maximise
• MR=MC to equate levels of production
• SR firms will supply if price is above AVC
• LR will supply only if meets AC
• Profit maximisation occurs when TR-TC is the greatest
Long Run
• Non-Keynesian economists believe firms maximise profits in LR
• SR Profit Max means firms will adjust price and output in response to changes in
market
o However, rapid changes might affect position in market – consumers view
this as a sign of profiteering and switch to other brands
o Price changes also cause costs – menu costs etc.
Divorce of ownership from control
• In large businesses – owners appoint directors and managers to run on their behalf
• Owners want to profit maximise – directors and managers want to maximise their
own benefit
o Includes their own pay and bonuses
• Profit maximising remains important – they need to remain in profit – if loss the firm
shut down, if doing poorly –takeover is possible
o Directors and managers need to make good enough profit to satisfy owner
• This is called profit satisficing – firm aims to make minimum accepted level of profit
and then pursue other aims
,Revenue Maximisation
• Uses the theory of divorce of ownership from control – objective of managers is to
maximise total revenue for the firm
• TR maximised when MR =0
• Minimum level of profit accepted is normal profit – more profit can be made if profit
maximising was its objective
• Oligopolistic firms make abnormal profits in LR
o Not applicable to perfect competition or monopolistic competition
Sales Maximisation
• Maximise sales volumes – managers can also justify rewards by pointing to sales
• AC=AR is where sales is maximised (Normal profits are made at this point)
o Increasing sales beyond this will lead to a loss which will not satisfy sales
maximisation
, Revenues, Costs and Profits (3.3)
Revenue
Total Revenue (TR) is the amount of money a firm receives from sales over a certain period
of time
• TR= Price x Quantity
Average Revenue (AR) is the revenue per unit sold (Price – demand curve)
• AR = TR/Q = price
Marginal Revenue (MR) is the addition to revenue of producing one extra unit
• MR = Change in TR/ Change in Q
Revenue Curves
When price is constant – (Demand is elastic) – MR = AR = D
• £5 price – if sell 3 for £15 and 1 for £5
o MR is £5 and AR £5
When price is constant – Total revenue is upward sloping as sales increase
(TR increases by 5 as output increases by 1)
When a firm has to lower price to achieve higher sales, the price of the next additional unit
will be less and less.
• MR will be downward sloping (2x as steep as AR
curve)
• AR will also fall
Revenue and Price Elasticity
• When price is constant, AR and MR are horizontal,
hence demand is perfectly elastic
• As price falls, when total revenue is still increasing,
demand is price elastic as a FALL in price still leads to
INCREASED revenue
• When total revenue falls, demand is price inelastic as
a fall in price leads to a fall in total revenue
, Production
Short Run and Long Run
• Short run – Some factor inputs are fixed in supply – usually fixed capital
o Firm could, employ more workers and use more raw materials BUT space is
limited and cannot be changed in the short run
• Long run – all factor inputs are variable – producer can vary amount of labour, land
and capital if they want
o Firm could move to a bigger factory, employ more workers and use more raw
materials
The Short Run: Diminishing Returns
• Short run, at least one factor is fixed – if a firm uses capital and labour, only labour
can be varied
• Output would initially rise the more workers you employ
• However, there is an optimum level of production which is productively efficient
o 10,000 workers in a factory designed for 500 people – not efficient
• This is the Law of Diminishing Returns or Law of Diminishing Marginal Productivity
Total, average and marginal products
• Total Product is the quantity of output by given number of input
over period of time
• Average Product is the quantity of output per unit input
• Marginal Product is the addition to output produced by an extra unit
of input
• Initially marginal product rises but 5th procures less than 4th.
o Diminishing Marginal Returns applies between worker 4 and
5
o Diminishing average returns set in between 6 and 7
The Long Run: Returns to scale
• Law of Diminishing Returns assume firms operate in the short run
• In Long Run, firms can vary all their factor inputs
• Increasing Returns to Scale
o Equal percentage increase in inputs to production leads to a greater
proportionate increase in output
o If all Inputs double but output trebles – increasing returns to scale occurs
• Constant Returns to Scale
o Equal percentage increase in inputs to production leads to the same
percentage increase in output
• Decreasing returns to scale
o Equal percentage increase in inputs to production leads to a greater
proportionate fall in output
