Understanding Firms

Definition of a Firm

• A firm combines land, labor, and capital (inputs) to produce goods and services (outputs).
• Entrepreneurs organize these resources to decide how much to produce and for whom.

Classification of Firms

By Industrial Sector

1. Primary Sector: Involves extraction and production of natural resources (e.g., farming).
2. Secondary Sector: Involves manufacturing and construction (e.g., factories turning raw materials into goods).
3. Tertiary Sector: Involves providing personal and business services (e.g., education, banking).
4. Paternal Sector: A subsection of the tertiary sector focused on knowledge-based services (not required for this course).

By Ownership

• Private Sector: Firms individually owned, focused on profit maximization.
  • Types: Sole traders, partnerships, limited companies (private and public), cooperatives, charities.
• Public Sector: Firms owned by the government, focusing on providing public goods rather than profit.

Types of Private Sector Firms

1. Sole Trader: One owner, unlimited liability, responsible for all debts.

   • Advantages: Full control, easy to set up, keep all profits.
   • Disadvantages: Limited capital, unlimited liability, risk of losing personal assets.

2. Partnership: Between 2-20 partners, can share responsibilities and capital.

   • General Partner: Unlimited liability, makes decisions.
   • Silent Partner: Limited liability, no decision-making role.

3. Joint Stock Company: Owned by shareholders, limited liability.

   • Private Limited Company: Shares sold privately, limited number of shareholders.
   • Public Limited Company: Shares sold publicly, larger number of shareholders.

4. Cooperatives: Owned by members for mutual benefit, one member one vote.

   • Types: Worker cooperatives (owned by employees), retail cooperatives (bulk buying for discounts).

5. Charities: Not profit-driven, run by trustees, funded by donations.

Public Sector Firms

• Owned by government, provide public and merit goods, often natural monopolies (e.g., electricity, water).
• Funded by taxes, not aimed at profit but public welfare.

Size of Firms

• Small Firms: Less than 50 employees, may operate without many departments.
• Large Firms: More than 50 employees, often have specialized departments.
• Measures of Size: Workforce, internal organization, capital investment, market share.

Reasons Small Firms Remain Small

1. Market size is small.
2. Inability to raise capital for expansion.
3. Technology reducing the need for larger scale production.
4. Personal preference of owners to keep business small.

Advantages of Small Firms

• Easy to set up and run.
• Owner-run, allowing quick decision-making.
• May receive government support.

Disadvantages of Small Firms

• Full responsibility on owner.
• Limited financial resources.
• Higher average costs due to lack of economies of scale.

Growth of Firms

Internal Growth (Organic Growth)

• Expanding scale of production through more equipment or larger premises.
• E.g., opening new branches or campuses.

External Growth (Integration)

1. Merging: Combining two firms to create a larger entity.
2. Acquisition: One firm takes over another.

Economies of Scale

• Definition: Reduction in cost per unit as output increases.
• Types:
  • Internal Economies: Cost advantages gained individually by a firm.
  • External Economies: Cost advantages that benefit an entire industry.

Internal Economies of Scale Examples

• Marketing, managerial, labor, financial, technical, research and development, risk-bearing economies.

External Economies of Scale Examples

• Improved transport links, education facilities, supplier developments, housing amenities, associated services.

Diseconomies of Scale

• Internal Diseconomies: Increased costs due to inefficiencies within a growing firm.
• Examples: Management problems, technical issues, failure to sell output, industrial disputes.
• External Diseconomies: Increased costs impacting all firms in the industry.
• Examples: Increased labor costs, congestion, pollution, housing costs.

Summary

• Growth can lead to both economies and diseconomies of scale depending on the firm's management and external factors.
• Important to understand the distinctions between types of firms and their implications on the economy.