Growth and Survival of Firms: five questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
LMN Ltd operates as a relatively small, family-owned producer in an industry dominated by a few large firms. Its product is unique so the owners are confident they will be able to sell enough to provide them with sufficient revenue to allow a minimum acceptable level of performance for the firm.
Other than survival, what is the most likely objective of LMN Ltd?
Answer: B.
The correct answer is B: profit satisficing.
Profit satisficing means earning enough profit to keep the owners and any other stakeholders content, rather than pushing for the maximum possible. Two details in the question point to it. The firm is family-owned, so there are no outside shareholders demanding the highest possible return, and the owners themselves choose how hard to pursue profit. And they are confident of achieving a "minimum acceptable level of performance", satisfactory, not maximal. Family firms commonly trade profit for other things they value: independence, a manageable workload, control over the business.
Why the other options are wrong:
Profit satisficing means earning enough profit to keep the owners and any other stakeholders content, rather than pushing for the maximum possible. Two details in the question point to it. The firm is family-owned, so there are no outside shareholders demanding the highest possible return, and the owners themselves choose how hard to pursue profit. And they are confident of achieving a "minimum acceptable level of performance", satisfactory, not maximal. Family firms commonly trade profit for other things they value: independence, a manageable workload, control over the business.
Why the other options are wrong:
- A, profit maximising, would require the firm to push output to where MC = MR regardless of the effort involved. The phrase "minimum acceptable level" is explicitly inconsistent with maximising.
- C, revenue maximising, is typically the objective of managers whose pay or status depends on the size of the business, a symptom of separated ownership and control, which a family firm does not have.
- D, sales maximising, has the same difficulty and would also mean expanding well beyond the scale the owners are content with.
Question 2
The manufacture of some sports equipment is dominated by very large firms but there are also smaller firms in the industry.
What enables a small firm to exist in such an industry?
Answer: D.
Small firms coexist with very large ones by serving what the large ones cannot serve profitably, and personalised equipment is the clearest example: a bespoke racket or a custom-fitted boot needs flexibility, direct contact with the customer and short production runs, none of which a mass producer geared to long standardised runs does well. That is D. A describes the industry being dominated by a few large firms, which makes survival HARDER for a small firm rather than easier, since a high concentration ratio is a symptom of scale advantages. C, average cost falling as a large firm expands, is a description of economies of scale, and those are precisely the advantage that shuts small firms out of the mass market. B works against them too, because high start-up costs are a barrier to entry, and a market with high sunk costs of that kind is not in fact contestable, so the option contradicts itself as well as pointing the wrong way.
Question 3
What would be most likely to allow the survival of small firms in an economy?
Answer: B.
Small firms survive where being large brings no advantage, and personal services are the clearest case: haircuts, plumbing, tailoring and care work are delivered face to face, cannot be stockpiled or standardised into long production runs, and depend on the relationship between the individual supplier and the customer. As those services take a larger share of national output, more of the economy is made up of activity where scale buys nothing. An increase in the cost of borrowing bears down hardest on small firms, which have less collateral and no access to the bond and equity markets larger firms use. A rapid rate of change in information technology demands continual investment and specialist staff, which favours firms with the resources to keep up. A higher ratio of capital to labour points towards production methods built on expensive equipment, and heavy fixed capital is precisely what generates economies of scale and rewards size.
Question 4
What is likely to make it more difficult for a small firm to survive?
Answer: C.
The correct answer is C: the absence of effective barriers to the entry of potential competitors.
With no barriers to entry, any profit a small firm manages to earn attracts new entrants. Its market share is competed away, its prices are driven down towards average cost, and there is no protected niche in which it can establish itself. Survival becomes precarious because the firm can never accumulate the margin needed to invest and grow.
Why the other options help small firms:
With no barriers to entry, any profit a small firm manages to earn attracts new entrants. Its market share is competed away, its prices are driven down towards average cost, and there is no protected niche in which it can establish itself. Survival becomes precarious because the firm can never accumulate the margin needed to invest and grow.
Why the other options help small firms:
- A, consumer preference for distinctive non-standardised products, is a considerable advantage. Mass production suits large firms, while bespoke and specialised output plays to a small firm's flexibility and close customer relationships.
- B, lower interest rates, reduces borrowing costs. Small firms depend heavily on bank credit and hold few reserves, so cheaper finance helps them disproportionately.
- D, decreasing returns to scale, is the sharpest distractor. Decreasing returns mean average costs rise as output expands, which removes the large firm's cost advantage and leaves small firms competitive. The word to read carefully is "decreasing"; it is increasing returns to scale that squeeze small firms out, by making size itself a cost advantage.
Question 5
What would be a reason why small firms do not survive?
Answer: A.
The question asks why small firms fail rather than why they survive, so three of these are reasons for survival and one is an obstacle. Significant economies of scale are the obstacle: where average cost keeps falling as output grows, a large rival produces each unit more cheaply, and a small firm cannot match its price without making a loss, so it is squeezed out. Supplying personal services works the other way, because services delivered face to face cannot be produced in long standardised runs and scale buys the large firm nothing. A limited market for the product is also a reason for survival, since there is not enough demand to support a large plant and a big firm would be operating far below its efficient output. Lower risk in a small owner-managed firm is again an advantage rather than a difficulty, because the owner can respond quickly and has less capital exposed. Only the cost advantage of size actually drives small firms out.
What this practice covers
These questions are drawn from past CIE 9708 papers. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on growth and survival of firms, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Calling every takeover horizontal integration without checking the stage of production.
- Confusing backward with forward vertical integration. Backward goes towards the supplier.
- Treating a merger and a takeover as identical. A merger is agreed, a takeover need not be.
- Assuming growth always lowers average cost, forgetting diseconomies and integration costs.
- Explaining why small firms survive purely in terms of finance.
- Placing cartels under market structures. Cambridge examines them here, in 7.7.
- Stating that cartels are unstable without explaining the individual incentive to exceed quota.
- Assuming a cartel must include every producer, when it needs only enough combined share to move the price.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Growth and Survival of Firms revision notes.