Economics exam theme three
1.Reasons of firms tend to grow
A) Experience economies of scale, lowering average cost by increasing output, improve profits
B) Expanding the business could improve market shares and ability to influence prices and market
power, it could also prevent new entrants to entry
C) Access to financial can be improved
Limitations: size of the market, regulations
EV: finance, demand, trends, rivals, brand loyalty, supply, market share, market size, barriers to
entry, political, economical, social, legal, technological, environmental, business objectives
2.The principal agent problem is a conflict in priorities between the owner of an asset and the
person who whom control of the asset has been delegated (this occurs when there is a
separation of ownership and control) (this would eventually lead to satisficing behaviour, where
the firm is making enough profits to keep shareholders happy and also able to satisfy mangers’
objectives) (this is link to business objectives)
3.The private sector refers to that part of the economy that is owed and run by individuals or
groups of individuals, the public sector refers to that part of the economy that is owned or
controlled by local or central government.
Almost all private sector organisations are run to maximise the financial benefits for their
shareholders, they may not necessarily profit-maximiser, but their long-term goal is to make
money. Some private sector organisations are not-for-profit, they aim to maximise social welfare,
they are not large enough to be classified as charities
4.Organic growth is where the firm grows by increasing their output, including increased
investment, labour, range of products and so on. (growth a firm achieves from its existing businesses
rather than newly acquired ones) Inorganic growth is where the firm grows through mergers,
acquisitions and take-overs.
+ve: less risky to loss control (o)
no need to adapt to new management styles and business cultures, less uncertain (o)
able to reach wider groups of suppliers and customers, can gain market shares and power (i)
able to generate more ideas (i)
reduce overlapping roles can save cost (i)
-ve: unable to gain market share and assets, extend range of industry and improve diversification (o)
unable to generate new ideas (o)
can be very costly and may be experiencing diseconomies of scale (i)
5.A merger is where two or more companies combine their operations to form a new entity
(Companies usually merge their assets, liabilities, and personnel to create a new organisation,
aims to achieve synergies, economies of scale, or other strategic objectives)
An acquisition happens when one company buys another company (The acquiring company gains
control over the target company by obtaining its assets, liabilities, and equity interests, it can be
friendly, with the agreement and cooperation of both parties or hostile, when the target
company resists the acquisition attempt)
Takeovers are a type of acquisition that is typically hostile and does not involve the target
company’s consent (it occurs when one company acquires a controlling interest in another
without the target company's consent or cooperation. The acquiring company bypasses the
target's management and shareholders by making a direct offer to the shareholders or through
other means, such as a tender offer or a proxy fight)
, Integration is growth through merger, acquisition or takeover
Types of integrations
A) Vertical integration is the integration of firms in the same industry but at different stages in the
production process (Backward integration involves merging with upstream companies such as
suppliers and producers, forward integration involves merging with downstream companies
such as distributors or retailers)
+ve: expanding the chain of production allows the firm to enjoy a lower cost, better efficiency and
productivity, help reaching a higher profit margin
can reduce potential excess demand and supply issues as the firm supplies for itself
can control the quality of suppliers and ensure delivery is reliable with backward integration
forward integration can secure retail outlets and raise competitiveness
-ve: firms may have no expertise in the industry they took over
firms may face management problems due to culture clash in business
B) Horizontal integration is the integration of firms in the same industry at the same stage of
production
+ve: can reduce competition as a competitor is taken out, market shares can also be increased,
strengthening market power and bargaining power
able to specialise, rationalise and consolidate, reducing the areas of the businesses which are
duplicated, making the firm more cost efficient
growing in a market where the business is already has expertise, less risk of failure
-ve: increase risk as it does not improve diversification, this is placing all eggs in one basket
Examples: Facebook, Instagram, WhatsApp formed Meta; British Airways and Iberia merged
C) Conglomerate integration is where firms in different industries with no direct connections
integrate
+ve: improve diversification, lower the risk of failing, also can cross-sell products to consumers
able expand market shares in different markets while sharing the same resources
-ve: firms are going into markets in which they have no expertise, the risk of failing is high
less likely to be able to bulk buy and benefit from economies of scale
Example: Argos being placed on Sainsburys)
*Evaluation: link concepts with principal agent problem, economies of scale, diseconomies of
scale, competition, intangible assets, share knowledge, also the impacts on different stakeholders
6.Limitations of business growth
A) Size of the market: demand for a good and methods of production restrict a size of the business
B) Access to finance: growing a business involves financial support, access to different sources of
finance determines the ability of investing
C) Owner objectives: some owners may not want their business to grow any further as they are
satisfied with their current profits
D) Regulation: in particular industries, a firm may own no more than 25% market share due to
competition law which prevents monopolies
7.A demerger is the separation of a large company into two or more smaller organisations,
particularly as the dissolution of an earlier merger
Reasons for demergers
A) Lack of synergies: failing to be efficient, leading to diseconomies of scale
B) Value of the company/share price: overall value is brought down because of the lack of success or lack
or potential for growth
C) Focussed companies: by focusing on one are, managers can improve their skills and knowledge and
improve overall efficient and productivity
D) Avoid attention from the competition authorities
, Impacts on different stakeholders
A) Workers: some may get promoted, some may become redundant (job role no longer needed)
B) Businesses: concentrating on a smaller core may improve efficiency, leading to more innovation
and better chance of survival but it depends on how successful the business
achieves economies of scale after demerger
C) Consumers: if the business is more efficient and productive after the demerger, consumers can
enjoy better products and cheaper prices, vice versa
(Synergy is the concept that the value and performance of two combined companies will be greater than
the sum of the separate individual parts)
8.Economies of scale are cost advantages reaped by companies when production becomes
efficient, diseconomies of scale occur when the expansion of output comes with increasing
average unit costs
Reasons lead to diseconomies of scale
A) Communication breakdown
B) Lack of motivation (clashes of corporate cultures)
C) Lack of coordination (clashes of corporate cultures, more levels of hierarchy)
D) Loss of focus by the management and employees (principal agent problem)
Internal economies of scale measure a company’s efficiency or production and occur because of
factors controlled by its management team
External economies of scale happen because of larger changes within the industry, so when the
industry grows, the average costs of business drop
Types of internal Examples of internal Types of external Examples of external economies of
economies of scale economies of scale economies of scale scale
Technical, Purchasing, advertising, bulk buying, Infrastructure, Suppliers move closer to a growing
Marketing, Risk- cheap loans for certain Suppliers/Specialisacluster of firms in an industry, firms in
bearing, Financial, firms, innovation, best tion, Innovation, the same supply-chain cluster to be
Managerial employees attracted to Lobbying nearer to each other, new motorway
status of firm, capital opens, cross rail, area becomes
intensive production renowned for a quality service,
methods (when products political lobbying by large firms
are mainly produced by reduces the amounts of strict
machines and robots) regulations, students from a world
class university locate near firms after
graduating
*Diagram which shows minimum efficient scale, economies of scale and diseconomies of scale
(internal economies of scale cause a movement down the long run average cost curve for a business,
whereas external economies of scale cause a downward shift in the long run average cost curve, lower
costs represent an improvement in production efficiency)
9.Business objectives
A) profit maximisation: where businesses maximise their revenue and minimise their total costs
(it is where MC=MR)
(profit maximising rule is also the loss minimising rule)
B) revenue maximisation: where businesses maximise their total revenue
(it is where MR=0)
C) sales maximisation: where businesses are selling as many units as possible
(it is where AC=AR)
D) profit satisficing: where businesses are making enough profit to keep shareholders happy and
meanwhile able to satisfy mangers or other stakeholders’ objectives
