Chapter - 19

ADVANTAGES AND DISADVANTAGES OF

LARGE AND SMALL FIRMS

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

 □Advantages of Large firms:
1) A large firm may enjoy economies of scale, thus lower long run average cost.
2) Lower cost will make the firms more competitive and help to increase market share.
3) They can dominate the market and increase profits by charging higher prices.
4) They can reduce the risk of trading by diversification, aka, extending the range of
products in the market.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

 □Disadvantages of Large firms:
1) Management diseconomies - A large firm may become difficult to control and
coordinate. This can increase supervision cost leading to management diseconomies.
2) Bureaucracy - Large firms may experience increased bureaucracy when too many
resources are used up in administration, leading to higher average cost.
3) Labour diseconomies - Large firms are at a greater risk from lack of motivation of
workers, strikes and other industrial actions.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

□Advantages of Small firms:
1) Flexibility - Small firms can adapt to changes more quickly. This is because the owner
who takes all the decisions is actively involved.
2) Personal Service - As firms get bigger, it often becomes too difficult to give individual
personal service to customers.
3) Lower wages cost - Many workers in a small firm do not belong to trade unions. As a
result, their negotiation power is weaker. Hence, they are often paid relatively low
wages.
4) Better communication - Since small firms have fewer employees, communication
tends to be informal and more rapid than in large organizations.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

 □Disadvantages of Small firms:
1) Higher cost - Small firms cannot exploit economies of scale because their output
is limited. Hence, they experience higher average cost.
2) Lack of finance - Small firms often struggle to raise finance. For example- small
firms cannot sell shares in the stock market to increase their capital.
3) Difficulty in hiring quality staff - Small firms may find it difficult to attract highly
qualified and experienced staff; one reason might be that they lack resources.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

□Factors influencing the growth of firms:
1) Government regulation - Government often favors the consumers and promotes
healthy competition between firms.
2) Access to finance - Many owners will hope to grow their businesses. However, they
may not have the access to the finance needed for the expansion.
3) The desire to spread risk- Expansion of business will make the firm’s product range
wider and more diversified. This enables them to spread the risks of trading.
4) Economies of scale- One of the main motives for growth is to reduce average cost.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

□Reasons for the existence of small firms
1) Size of market - The market of some goods is small. As a result, some firms do not need
to grow large. For example - luxury products.
2) Nature of the market - In some markets, the competition is very fierce, and that
discourages firms to grow larger.
3) Aim of the entrepreneur - Some business owners do not want to grow their business.
They may be happy running a small business and making enough profits to satisfy their
needs.
4) Diseconomies of scale - Once a firm reaches a certain size, any further growth results in
diseconomies of scale. If the firm expands beyond the minimum efficient scale, average
cost starts to rise and that discourages firms to grow larger.
5) Lack of finance - Many owners will hope to grow their businesses. However, in some
cases, they may not be able to afford that growth.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

Types of Integration
i. Horizontal Integration: Merger between firms at the same stage of production and the same industry.
For example: Merger between Banks; FedEx and TNT Express merged in April 2015.
ii. Vertical Integration: Merger between firms who are in the same industry but at different stages of the
production process.
a. Backward Vertical Integration: Merger with suppliers of raw materials in the supply chain. For
example, Manufacturer of Chocolate merging with a cocoa plantation.
It ensures an adequate supply of good quality raw materials and reduces intermediary costs.
b. Forward Vertical Integration: Integration with firms in the output distribution chain, allowing firms to
be closer to the final consumer of the product. For example, an oil refinery combined with the chain of
petrol station. It ensures greater control over distribution and marketing outlet.
iii. Conglomerate Integration: Integration between firms that are in different, unrelated industries. For
example, a car manufacturer merging with a chips manufacturer, Unilever.
This type of merger reduces the risk of trading through Diversification. When one firm faces difficult
times, another can cross subsidize.
However, such mergers can be unsuccessful due to lack of expertise in new markets.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

Effects of Merger for Firms:
Advantages:
i. Firms achieve economies of scale due to large scale production, which reduces long run average cost.
ii.It increases market share.
iii.
It decreases competition.
iv.The merged firms could benefit from Rationalization where unnecessary resources are eliminated,
making the firm more efficient.
v. The two firms will have shared resources such as Technology, which will lead to increased investment.
Disadvantages
i. Management diseconomies: The merged firms may grow too large, resulting in management
diseconomies of scale. Furthermore, financial and management cultures of the two firms might be
different, resulting into higher average cost.
ii. Increased bureaucracy and labour diseconomies.

Evaluation
Overall, most firms benefit from growth and economies of scale, and this is shown in their increased profits.

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1. Briefly explain two reasons why a government might to try to prevent
horizontal mergers.
► Mergers can reduce competition; so, if the government can prevent mergers
it will encourage competition. This can be done by the setting up of commissions
which study proposed mergers and prevent them if they do not encourage
competition. Privatization can lead to competition when a state-owned industry is
sold off to several different companies. Unlike the state-owned Monopoly, the
private firms will compete against each other. If the country opens up to foreign
trade, competition can increase. Joining a trading bloc will reduce trade barriers to
countries in the block which will make them more competitive.

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19

 THE END

AUNTORIP KARIM - CLASS VIII ECONOMICS - CHAPTER 19