Contents: 13 sections
Cambridge IGCSE Economics 0455
Syllabus points
- Explain the classification of firms by size and sector.
- Explain the causes and effects of the growth of firms.
- Explain why some firms stay small and why some merge.
Classifying firms
By sector:
| Sector | What it does | Examples |
|---|---|---|
| Primary | Extracts natural resources | Farming, fishing, mining, forestry |
| Secondary | Manufactures and builds | Car factories, food processing, construction |
| Tertiary | Provides services | Shops, banks, transport, healthcare, education |
As countries develop, employment usually shifts from primary to secondary and then to tertiary, a pattern you can use in development questions (5.4).
By size, measured several ways:
- Number of employees: the most common measure.
- Value of output or sales revenue (turnover).
- Capital employed: the value of machinery and buildings.
- Market share.
No single measure is perfect. A car plant may have few workers but huge capital; a cleaning company may have many workers and little capital. Saying that a measure depends on the industry is worth a mark.
Why firms grow
- To gain economies of scale, lowering average cost (3.6).
- To increase profit by selling more.
- To gain market power and more control over price.
- To spread risk across more products or markets.
- Because managers want the status and security of running a larger business.
How firms grow
Internal (organic) growth, expanding by selling more, opening branches, or investing in new capacity. It is slower but easier to manage.
External growth, joining with another firm, through a merger (both agree) or a takeover (one buys the other).
Three kinds of integration, and IGCSE tests the distinction:
| Type | What it means | Example | Main benefit |
|---|---|---|---|
| Horizontal | Two firms at the same stage of the same industry | Two supermarket chains merge | Larger market share, economies of scale |
| Vertical | Firms at different stages of the same industry | A coffee chain buys a coffee plantation (backward) or a brewery buys pubs (forward) | Secures supply or secures outlets, cuts costs |
| Conglomerate | Firms in unrelated industries | An airline buys a hotel chain | Spreads risk |
Remember the direction: backward vertical is towards the supplier; forward vertical is towards the customer.
Why some firms stay small
This is the half of the topic students most often neglect:
- The size of the market. A village bakery or a local hairdresser has limited local demand.
- Personal or customised service. Customers may want individual attention that a large firm cannot give.
- Niche markets. Specialist products have too few buyers to justify a large firm.
- Lack of finance. Small firms find borrowing harder and more expensive.
- Owner's choice. Many owners prefer to stay small and keep control.
- Flexibility. Small firms adapt quickly to changing demand.
- Low barriers to entry in some industries mean many small firms can coexist.
Effects of growth
Advantages: lower average costs from economies of scale, greater market power, more profit, better access to finance, risk spread across markets.
Drawbacks: diseconomies of scale from communication and coordination problems, less flexibility, possible job losses after a merger, and the risk of reduced competition harming consumers, which is why governments review large mergers (3.8).
Worked example
A supermarket chain buys a large dairy farm.
The supermarket is at the retail stage; the farm is at the production stage of the same industry → this is vertical integration, and specifically backward vertical, because the supermarket is moving towards its supplier.
Why do it: it secures a reliable supply of milk, removes the supplier's profit margin, and gives control over quality and cost.
Drawbacks: the supermarket now has to run a farm, which is outside its expertise; it is exposed to risks in farming such as disease and weather; and combining two very different businesses may create diseconomies of scale.
Evaluation. Whether it is worthwhile depends on how much of the supermarket's costs milk represents, and whether it can manage the farm as efficiently as a specialist would.
Common exam mistakes
- Confusing horizontal with vertical integration.
- Getting backward and forward vertical the wrong way round.
- Saying growth is always beneficial, mention diseconomies of scale.
- Ignoring the reasons firms stay small, which is half the syllabus point.
- Using only employee numbers to measure size without noting its limits.
Exam technique
When identifying an integration type, say which stage each firm is at; that is what proves you understand it rather than guessing.
For "should this firm grow?" questions, weigh economies of scale against diseconomies, and mention the effect on consumers if competition is reduced.
For "why do small firms survive?", give at least three distinct reasons, market size, personal service, and owner choice make a solid set.
Building an answer
4 marks, "Explain two reasons why some firms remain small."
The market may be small or highly localised, a village shop serves a limited area, so there is no volume to grow into.
Some products require personal service or customisation, so the advantages of large-scale production do not apply. A tailor or a hairdresser cannot standardise the work.
6 marks, "Analyse the advantages a firm gains from growing larger."
Internal economies of scale reduce average cost: bulk buying lowers input prices, specialised managers raise productivity, and large capital equipment becomes affordable.
Financial economies matter too, banks lend to large firms at lower rates because they are seen as less risky.
Lower average cost allows the firm either to cut price and win market share, or to keep price and earn higher profit for reinvestment.
Growth has limits, though: beyond a point diseconomies set in as communication slows and coordination becomes harder, so average cost rises again.
The final sentence is the evaluation, and it is what an "analyse" question at 6 marks is looking for.
Economies and diseconomies of scale
| Internal economies (from the firm growing) | Internal diseconomies |
|---|---|
| Purchasing: bulk discounts | Communication becomes slow and distorted |
| Technical: larger, more efficient machinery | Coordination across departments is harder |
| Managerial: specialist managers | Workers feel remote from management, so motivation falls |
| Financial: cheaper borrowing | Duplication of effort between divisions |
| Marketing: advertising spread over more units | |
| Risk-bearing: diversified product range |
External economies come from the industry growing rather than the firm: a skilled local labour pool, specialist suppliers nearby, shared infrastructure.
A real case to quote
Aldi and Lidl. Both keep costs down through a deliberately narrow product range, a fraction of the lines a full-range supermarket carries, which maximises purchasing economies on each item and simplifies logistics. It shows that economies of scale are not simply about size but about how the scale is organised.
Check you have it
What will happen to a firm that expands to take advantage of economies of scale?
More questions on firms →Quick revision
- Sectors: primary (extract), secondary (make), tertiary (services).
- Size measured by employees, turnover, capital or market share, each imperfect.
- Firms grow for economies of scale, profit, market power and to spread risk.
- Internal growth is organic; external is merger or takeover.
- Horizontal = same stage, same industry. Vertical = different stages (backward to supplier, forward to customer). Conglomerate = unrelated.
- Small firms survive on market size, personal service, niches, flexibility and owner choice.