Cambridge International AS and A Level Economics: Growth and survival of firms (9708) – Revision Notes

These notes condense section 7.7 (Growth and survival of firms) of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. The syllabus puts topics 1 to 6 at AS Level and topics 7 to 11 at A Level; this unit belongs to the A Level group only. All numbers are made up for illustration. Read the study guide for full explanations, then test yourself with the practice set.

Related links: Cambridge A Level Economics hub, printable checklist, free diagnostics and the price system revision notes.

Key definitions

Term	Meaning
Organic (internal) growth	Growth from within by selling more, opening outlets or adding capacity
Diversification	Moving into new products or markets to spread risk
Merger	Two firms agree to combine into one
Takeover	One firm buys control of another, sometimes against its wishes
Horizontal integration	Joining with a firm at the same stage in the same industry
Backward vertical integration	Joining with a supplier
Forward vertical integration	Joining with a distributor or retailer
Conglomerate integration	Joining with a firm in an unrelated industry
Cartel	Formal agreement among firms to fix price or output
Principal	The owner (shareholder)
Agent	The manager who acts for the owner
Minimum efficient scale	Lowest output at which long-run average cost is minimised
Concentration ratio	Combined market share of the largest firms

7.7.1 Reasons for different sizes

Small firms persist when:

• the market is small or local
• the product is niche or personalised
• the owner wants control
• finance is scarce
• diseconomies of scale begin early

Large firms grow when:

• economies of scale cut average cost
• market power raises price-setting ability
• risk can be spread
• finance is easier to raise
• managers value growth

Memory hook: Size follows minimum efficient scale. A large minimum efficient scale compared with the market gives few big firms. A small one allows many small firms.

Small calculation. Total cost of 30,000 cu at 500 units gives average cost 60 cu. At 2,000 units total cost 90,000 gives 45. At 5,000 units total cost 300,000 gives 60. Average cost falls from 60 to 45 (economies of scale), then rises back to 60 (diseconomies of scale).

7.7.2 Internal growth

	Organic growth	Diversification
What	More of the same product or capacity	New products or markets
Aim	Larger market share, lower unit costs	Spread risk
Finance	Retained profit, loans	Retained profit, loans
Pros	Control kept, no premium, low culture clash	Smoother profits
Cons	Slow	Unfamiliar markets, loss of focus

Growth rate = (new − old) ÷ old × 100. If sales rise from 250 to 290, growth = 40 ÷ 250 × 100 = 16%.

7.7.3 External growth: integration

Method in steps for an integration question:

1. Name the type (horizontal, backward, forward or conglomerate) and justify it.
2. Give the reason the firm wants it (cost, power, security, risk).
3. Trace the effect on consumers, workers, rivals and shareholders.
4. Evaluate: what could make the outcome different?

Type	Main reasons	Main risks
Horizontal	Economies of scale, market share, fewer rivals	Higher prices, authority scrutiny, diseconomies
Backward	Secure supply, control quality, capture margin	Fixed cost of running the supplier, loss of supplier competition
Forward	Secure outlets, capture retail margin	Unfamiliar retail skills
Conglomerate	Spread risk, use surplus funds	Few synergies, management stretch

Small calculation (market share). Two firms hold 35% and 25%. Merged share = 35 + 25 = 60%. A merged share this large may attract investigation by a competition authority.

Forward integration margin. A firm sells to retailers at 8 cu a unit, who sell at 12 cu. Buying the retailer lets it capture the extra 12 − 8 = 4 cu a unit, but it now bears retail costs.

Why many mergers disappoint:

• Culture clash and poor communication.
• Expected savings do not appear.
• The price paid was too high.
• The new firm becomes too large to manage (diseconomies of scale).

Who gains and loses:

• Consumers: lower prices if savings are passed on, higher prices if competition weakens.
• Workers: possible redundancies, but possibly more promotion routes.
• Suppliers and rivals: weaker bargaining position, risk of being shut out.
• Shareholders: gain if value rises, lose if the deal is overpriced.

7.7.4 Cartels

Conditions for an effective cartel:

1. Few firms.
2. Similar or homogeneous products.
3. High barriers to entry.
4. Similar costs and stable demand.
5. Easy detection and punishment of cheating.
6. Weak enforcement of competition law.
7. Trust and a leader.

Why each condition matters: it makes agreeing a common price easier, or makes policing the agreement easier, or stops new firms undercutting it.

Consequences:

• Higher price and lower output than under competition.
• Lower consumer surplus and a deadweight loss.
• Higher profit for members, but unstable because each member gains by cheating.
• Less pressure to cut costs, so X-inefficiency.
• Possible gains: price stability and profit for research. These are uncertain.

Small calculation. Demand P = 70 − Q and marginal cost 10 cu. A cartel acting as a monopoly sets MR = 70 − 2Q = 10, so Q = 30 and P = 40. Profit = (40 − 10) × 30 = 900. With five firms and equal quotas, each makes 6 units and profit 180. Competition would give P = 10, Q = 60 and zero profit.

Cheating logic. If rivals stick to quota, a firm that produces extra sells at a still-high price and gains. If all cheat, price falls and the cartel is back near competition. This is the Prisoner’s Dilemma.

7.7.5 Principal-agent problem

Cause: shareholders and managers have different objectives, and managers know more about the firm (asymmetric information).

Principals (shareholders) want	Agents (managers) may want
Profit and dividends	Salary and bonuses
Rising share price	Status, perks and empire building
Long-term value	Job security, less risk

Consequences: satisficing, revenue or sales maximisation, wasteful spending, short-term focus.

Solutions:

• Profit-related pay and share options.
• Monitoring through audits and independent directors.
• Shareholder votes and the threat of takeover.

Limits of the solutions: they cost money, can encourage short-term or risky behaviour, and dispersed shareholders find it hard to act together.

Evaluation prompts

• Integration: does the saving in cost exceed the loss of competition? Is entry easy enough to keep the merged firm in check?
• Cartels: how long can the agreement last when cheating is tempting and detection is slow?
• Principal-agent: do bonuses align interests, or do they push managers towards short-term targets?
• Size: is the minimum efficient scale large or small compared with the market?
• Always finish with a judgement and the condition on which it depends.

Must-know distinctions

• Merger versus takeover: agreed combination versus purchase of control.
• Organic growth versus external growth: from within versus by joining another firm.
• Backward versus forward: towards suppliers versus towards customers.
• Horizontal versus conglomerate: same industry versus unrelated industries.
• Principal versus agent: owner versus manager.
• Diversification (new products, can be internal) versus conglomerate integration (buying an unrelated firm).

Quick self-test

1. Name two reasons a firm may stay small.
2. A firm’s sales rise from 250 to 290. Calculate the growth rate.
3. What type of integration is a car maker buying a tyre supplier?
4. Explain one reason a supermarket might buy a farm.
5. Give two reasons a conglomerate merger may reduce risk.
6. State three conditions for an effective cartel.
7. With demand P = 70 − Q and marginal cost 10, find the cartel price and output.
8. Why do cartel members have an incentive to cheat?
9. Define the principal-agent problem.
10. Give two ways to reduce the problem.

Answers

1. Small or local market; niche product; owner wants control; difficulty raising finance; early diseconomies of scale (any two).
2. (290 − 250) ÷ 250 × 100 = 16%.
3. Backward vertical integration (the supplier is earlier in the chain).
4. It secures supply and quality, and captures the farm’s profit margin, protecting against price rises. It must be set against the cost of running a farm.
5. The two businesses have profits that move differently over time, so total profit is steadier. Losses in one can be covered by the other.
6. Few firms; similar products; high barriers to entry; similar costs; easy detection of cheating (any three).
7. MR = 70 − 2Q = 10, so Q = 30, then P = 70 − 30 = 40.
8. A firm that raises output while others keep to quota sells more at a still-high price and gains profit.
9. Managers (agents) pursue objectives that differ from the shareholders (principals) who own the firm, and the owners cannot fully observe managers’ actions.
10. Profit-related pay or share options; audits and independent directors (any two).

Where marks are usually lost

• Naming the type of integration without justifying why the firm wants it.
• Saying all mergers give economies of scale, without mentioning diseconomies.
• Writing about consumers only, and omitting workers, suppliers or shareholders.
• Listing cartel conditions with no link to how each makes the cartel work.
• Treating a cartel as stable, and forgetting the incentive to cheat.
• Mixing up principal and agent.
• Describing diversification and conglomerate integration as the same thing.
• Giving a one-sided answer with no judgement about which effects are likely to be larger.

Official syllabus

Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028, section 7.7 (Cambridge University Press & Assessment).