EDEXCEL A LEVEL ECONOMICS NOTES - 3.1 Business Growth (Detailed A* Notes)

STRONG A STAR CHAINS OF ANALYSIS PROVIDED THROUGHOUT:

3.1.1 Sizes and Types of firms

Why do firms remain small?

• Concentrate on niche markets → less competition for the business → can be more profitable → link to dynamic efficiency analysis points (covered in Efficiencies section)
• Focus on a small range of products → high quality → link to allocative efficiency & brand loyalty
• Lack of finances --> Do not have sufficient funds to invest and expand production for growth.
• Limited Economies of Scale in industry → e.g Coffee shops
• The objective of the owner may be to have more control and ownership
• Lower costs → pay less tax when small

EXAM QUESTION

Knowledge: Lack of finance to expand (1 mark)

Analysis: Expensive to open a new cafe (1 mark)

Principal-Agent Problem

• Principal = Shareholder/Owner
• Agent = Manager

There is a separation of ownership and control:

• Shareholders aim to maximize profits, while managers may prefer to maximize revenue and enjoy job perks like a comfortable office and an easier workload.
• This misalignment can lead to inefficiency, resulting in higher costs, lower profits, and higher prices.
• Managers may generate just enough profit to keep shareholders satisfied without maximizing it—this is known as profit satisficing.

Sectors of the Economy

• Public Sector: Industries where the government provides goods and services.
• Private Sector: Goods and services are provided by private businesses operating in a competitive free market.

Types of Organizations

• Profit Organizations: Businesses where the main objective is to generate profit.
• Not-for-Profit Organizations: Businesses that focus on social, charitable, or community-driven goals rather than profit.

3.1.2 Business Growth

a) How businesses grow: 

1.  organic growth 

Definition: Organic growth refers to the expansion of a business achieved through internal means, such as increasing sales and production, and developing new products.

Advantages

• Avoid the disadvantages of merging
• Develop natural experience 
• Economies Of Scale (EOS) benefits (including internal EOS & lower long run average costs).

Disadvantages

• Slow process as the whole process is independent → Rivals who merge can outcompete you as they can gain significant market share in a short period of time.

Vertical mergers

Backward Integration: Is a type of merger in which a company acquires or merges with another company that is positioned earlier in the production or distribution chain.

Advantages

• Access to supplies of raw materials → Elastic supply --> respond to consumer demand rapidly --> increase brand loyalty.
• Storage space
• Raise barriers to entry as fewer suppliers for new firms ⇒ reduce contestability -> Gives business more room to charge higher prices without worrying about new competitors entering and stealing profits.
• Economies Of Scale points apply here (Detailed coverage under Economies of scale notes)

Forward integration: A forward merger occurs when a company in an industry acquires or merges with another company that is further down the production or distribution chain.

Advantages

• Gain access to a larger client base and brand loyalty 
• Knowledge spill overs –> You can learn from the experienced business i.e. there operations, strategies etc.
• EOS points apply

3. Horizontal integration 

Definition: This is when a firm merges with another firm in the same production stage. For example, Pepsi and Coca Cola, or Samsung and Apple.

Benefit to firm

1. Greater market share and reduced competition ⇒ become monopoly if there market share surpasses 25% ⇒ obtain price making power, set high prices, and earn large profits ⇒ Predatory price in the long run to get rid of competitors 
2. EOS ⇒ LRAC falls ⇒ Increase efficiency in LR ⇒ lower prices in the LR ⇒ benefit low-income households, reduce equity issues --> consumer welfare improves and hence more allocatively efficient⇒ boost brand loyalty and make it difficult for new firms to enter and compete. 
3. Gain Economies Of Scale (EOS) as the firm is significantly larger ⇒ raises barriers to entry ⇒ reduce contestability of the market
4. Earn supernormal profits ⇒ boosts dynamic efficiency ⇒ invest in R&D/Training/Technology --> improve quality, choice --> Boost consumer welfare and allocative efficiency.

Benefits to consumers

1. EOS → lower prices in the long run → increase allocative efficiency 
2. Supernormal profits → dynamic efficiency → invest in quality & variety → increase allocative efficiency 

Disadvantages/Comments

• Diseconomies of scale ⇒ higher costs in long run ⇒ inefficiency --> less profits, less investment, poorer quality products etc.
• Depends on the level of regulation ⇒ if firms behave anti-competitive -> lead to scrutiny and harming public image --> Fall in sales and market share --> less power in long run
• Harm consumers ⇒ higher prices with monopoly power
• Lack of competition ⇒ less choice for consumers

4. Conglomerate Merger

Definition: This is when 2 firms merge but are in entirely in different markets. 

Examples: A game shop merges with a clothing shop.

Advantages

• Spread risk over differentiated product portfolio 
• The same advantages as a horizontal merger 

Exam question: Evaluate whether merging is beneficial to the firms?

Paragraph Example:

One advantage may be that when 2 firms merge they can become dynamically efficient. This is because when 2 firms merge they gain higher market share and can potentially become a monopoly if their MS exceeds 25%. This will give them the ability to profit max at MC:MR and set high prices at P to earn supernormal profits which can be seen in the shaded region. This is beneficial because the firm can use these supernormal profits to invest in R&D and innovate its product portfolio. Thus, increasing quality and consumer choice which should meet more consumer preferences and improve welfare. This makes the firm more allocatively efficient and can increase brand loyalty which will raise barriers to entry for the firm and reduce contestability as new firms will struggle to attract sales. Therefore, the firm and consumer both benefit from this dynamic efficiency. 

(Note: See how i clearly stated my point first, then went onto explain my point so the examiner can easily follow. I then started strong chains of analysis from 'This is beneficial because' and continued to chain my points logically. I closed the paragraph with a strong closing sentence to re-emphasis by point and give the examiner further clarity)

Demergers

• This is when two firms break up and become separate entities. 
• Analysis points will just be the opposite as mergers.