Theme 3

• Reasons for firm growth

  • To access economies of scale
  • To sell more goods and make more revenue
  • To gain market power
  • Increased security
• Monopoly


  A market structure with a single seller
• Monopsony


  A market structure with a single buyer
• Reasons why firms may remain small

  • Size of market
  • Access to finance
  • Owner objectives
  • Regulation
• Principal-agent problem

  Separation of ownership and control in large firms, due to differing aims of stakeholders
• Shareholders wish to maximize returns on investment

  Managers wish to maximize their own benefit
• This leads to many firms not profit maximising but profit-satisficing
• Public sector

  Owned by the government
• Private sector

  Owned by individuals
• Almost all private organisations are run to maximize profits for their shareholders
• Some non-profit organisations are run to maximize social welfare
• Organic growth


  A firm grows by increasing their output, e.g. opening new stores, increasing product range
• Organic growth


  • Firm keeps control of business
  • Less costly than integration
• Inorganic growth


  Takes the form of mergers or takeovers, also known as integration
• Benefits of Inorganic growth

  • Increased potential profit as the firm takes profit from both stages of production
  • Businesses can have control over quality of supplies and may be able to lower cost
• Forward vertical integration


  Firm moves towards the eventual consumer
• Backward vertical integration


  Firm moves back in the direction towards the supplier
• Horizontal integration


  • Firms in the same industry in the same stage of production integrate
  • Reduces competition and increases market share
  • Rationalisation where roles are duplicated can cut costs
  • Less risk of failure as both firms have industry expertise
  • Increased risk if whole market fails
• Conglomerate integration


  Firms in different industries with no obvious connection integrate
• Benefits of Conglomerate integration


  • Useful where there is no room for growth in one firm's market
  • Spreads the risk across multiple industries
• Constraints of business growth

  • Size of market
  • High risk entering industries with no expertise
  • Firms may not make enough profit for financing growth
  • Owner objectives
  • Regulation
• Demerger


  When a single company is broken back down into two or more components
• Reasons for demergers

  • Lack of synergies
  • Value of the company may be greater once separated
• Impacts of demergers


  • May be more efficient and successful for each firm to focus on their separate industry
  • Potential for promotion
  • Increased focus may lead to better efficiency and innovation
  • Loss of economies of scale
• Profit maximisation


  Occurs when MR = MC
• Revenue maximisation


  Occurs when MR = 0
• Sales maximisation


  Short term strategy to increase the size of the firm and market share, occurs when AR = AC
• Satisficing


  Managers produce satisfactory profits for the owners whilst following other objectives
• Law of diminishing returns

  There is a point where the addition of extra input doesn't proportionally increase output
• Economies of scale


  Advantages of large scale production which enable large businesses to achieve lower costs
• Internal economies of scale


  • Technical
  • Financial
  • Managerial
  • Marketing & purchasing
• External economies of scale


  • Better infrastructure
  • Firms closer together so suppliers locate closer
  • Educated labour locates to the area
• Reasons for diseconomies of scale


  • Principal-agent problem
  • Poor communication
  • Demotivated staff
  • Coordination issues
• Normal profits


  Return that is sufficient to keep the factor of production committed to the business
• Supernormal profits


  Firm is earning more than what is necessary to cover its opportunity cost
• Losses


  Firm cannot cover its costs
• Shut down point


  Firm should shut down when AR < AVC as increasing any more products will increase their losses
• Allocative efficiency


  Resources are used to produce goods and services customers want and value most highly, when MC = AR = D
• Productive efficiency


  Products are produced at the lowest average cost, meaning economies of scale have been fully exploited
• Dynamic efficiency


  Resources are allocated efficiently over time concerning investment which leads to innovation