Before analysing how firms behave, we need to know what kinds of firms exist, how and why they grow, and what they are actually trying to achieve — because a firm…
Before analysing how firms behave, we need to know what kinds of firms exist, how and why they grow, and what they are actually trying to achieve — because a firm's objective drives every decision that follows.
Learning objectives — by the end of 3.1 you can…
- distinguish the main types of business organisation; - explain organic and inorganic growth, the types of integration, and demergers; - explain the constraints on growth and why some firms stay small; - compare business objectives and explain the principal-agent problem.
Types of business
Spec: 3.1.1
| Type | Key feature |
|---|---|
| Private sector | Owned by individuals/shareholders, run for private gain. |
| Public sector (state-owned enterprises) | Owned by the government, often providing essential services. |
| For-profit | Aims to generate profit for its owners. |
| Not-for-profit | Any surplus is reinvested toward a social or charitable aim. |
| Co-operative | Owned by its members (workers or consumers), who share the profits. |
| Joint venture | Two firms combine resources for a specific project, sharing risk and expertise. |
Business growth & demergers
Spec: 3.1.2
Firms grow organically (internally, using their own resources — slower but lower-risk) or inorganically through a merger or takeover:
| Type of integration | Meaning | Main motive |
|---|---|---|
| Forward vertical | Joining with a firm closer to the customer (e.g. a manufacturer buying a retailer). | Secure distribution; capture retail margin. |
| Backward vertical | Joining with a supplier (e.g. a manufacturer buying a raw-material producer). | Secure and cheapen supplies. |
| Horizontal | Joining with a firm at the same stage of the same industry. | Market share, economies of scale, less competition. |
| Conglomerate | Joining with a firm in an unrelated industry. | Diversification — spreading risk. |
Constraints, staying small & demergers
- Constraints on growth: the size of the market, access to finance, owner objectives, and government regulation/bureaucracy. - Why some firms stay small: niche or local markets, owner preference, flexibility, and low barriers to entry that keep markets competitive. - Demergers split a business into separate firms — to focus on core activities, escape diseconomies of scale, raise shareholder value, or satisfy regulators. They affect businesses, workers and consumers.
Business objectives
Spec: 3.1.3
Not every firm chases maximum profit. The objective a firm pursues determines the price and output it chooses:
| Objective | Condition | Why pursue it? |
|---|---|---|
| Profit maximisation | MC = MR | Maximum returns for owners; funds investment. |
| Revenue maximisation | MR = 0 | Market share, manager rewards linked to sales. |
| Sales (volume) maximisation | AC = AR (break-even) | Sell as much as possible while still covering costs. |
| Satisficing | "Good enough" | Balancing the competing aims of different stakeholders. |
The divorce of ownership from control
In large companies, owners (shareholders) are separate from the managers who run the firm day-to-day. This creates the principal–agent problem: managers (agents) may pursue their own goals — bigger budgets, status, an easier life — rather than maximising profit for the owners (principals).
Exam Tip
You'll plot these objectives on a cost/revenue diagram in 3.3. Memorise the three conditions now — profit max MC = MR, revenue max MR = 0, sales max AC = AR — and you'll read any market-structure diagram instantly.
3.1 Recap — nail these
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