Cambridge IGCSE Economics: Classification, growth and size of firms (0455) – Revision Notes

These notes condense section 3.5 (Firms) of the Cambridge IGCSE Economics 0455 syllabus for examination in 2026: classification, small firms, growth, mergers, and economies and diseconomies of scale. The course is not tiered. Detailed knowledge of different types of structure of a firm is not required, so it is left out. For full explanations and longer worked examples read the study guide. Then try the practice questions, the course hub, the checklist and the free diagnostics. All numbers below are invented and illustrative.

3.5.1 Classification: three ways to sort a firm

Basis	Categories	Memory hook
Sector	Primary, secondary, tertiary	Raw, made, served
Ownership	Private sector, public sector	Owners versus government
Relative size	Small, medium, large	Always name the measure

• Primary: farming, fishing, mining, forestry.
• Secondary: manufacturing, construction, processing.
• Tertiary: retail, banking, transport, education, health care.
• Private sector: owned by individuals or groups; the main aim is usually profit.
• Public sector: owned and run by the government; aims may include service, low prices or jobs.
• Measures of size: employees, turnover, capital employed, output, market share.

Method in steps for a size question:

1. Name the measure (for example turnover).
2. Compare the figures.
3. Say the result may differ on another measure.

Worked reminder: Firm M has 12 employees and turnover of 540,000.

Turnover per employee = 540,000 / 12 = 45,000

3.5.2 Small firms: quick lists

Advantages	Disadvantages
Personal service	Few economies of scale
Quick decisions	Harder and costlier to borrow
Owner motivation	Weak bargaining power with suppliers
Low start-up costs	Depends on one or two key people
Serves niche markets	Lacks reserves in a downturn

Challenges: competition from large firms, raising finance, recruiting skilled staff, limited funds for advertising and new technology, and survival through a fall in demand.

Reasons small firms exist:

• Small or local market.
• Customers want personal, individual or craft products.
• Little scope for economies of scale in the industry.
• Owner prefers control or a quieter life.
• Niche market or supplier role.

Worked reminder: an illustrative small shop has revenue of 48,000, costs of 36,000.

Profit = 48,000 - 36,000 = 12,000
Profit / revenue = 12,000 / 48,000 x 100 = 25%

3.5.3 Growth: internal and external

	Internal (organic)	External
How	Sell more, open branches, launch products	Merger or takeover
Example	Rise in market share	Two firms join
Speed	Slower	Faster
Risk	Lower	Higher

Why firms grow: more profit, more market power, spread of risk, economies of scale, survival and manager or owner rewards.

Market share = firm’s sales / total market sales x 100.

Worked reminder: sales of 2.7 million in a market of 18 million.

Market share = 2.7 / 18 x 100 = 15%

Trap: sales up 10% in a market up 20% means market share falls.

Share index = 1.10 / 1.20 = 0.9167
A 20% share becomes 20 x 0.9167 = 18.3%

3.5.4 Mergers: three types

Type	What joins	Main gain	Main risk
Horizontal	Same industry, same stage	Scale economies, share, fewer rivals	Job losses, less competition, clash of cultures
Vertical	Same industry, different stage	Control of supply or sales channel	Unfamiliar stage, one fault spreads
Conglomerate	Unrelated industries	Spreads risk	Weak management knowledge, few cost savings

• Backward vertical: towards suppliers (a bakery buys a mill).
• Forward vertical: towards customers (a bakery buys cafes).
• Illustrative examples: two bus companies (horizontal); a clothing maker buying a cotton farm (backward vertical); a games developer buying a food firm (conglomerate).

Worked reminder: Firm X holds 11% of a market and Firm Y holds 7%. After a horizontal merger the combined share is 11 + 7 = 18%.

3.5.5 Economies and diseconomies of scale

Average cost = total cost / output.

• Economies of scale: average cost falls as output rises.
• Diseconomies of scale: average cost rises as output rises.

Output	Total cost	Average cost
300	9,000	30
600	12,000	20

Average cost falls by (20 / 30 - 1) x 100 = -33.3%, so this firm has economies of scale.

Internal economies	Meaning
Technical	Large, efficient machinery and mass production
Purchasing	Bulk discounts
Financial	Cheaper loans
Managerial	Specialist managers
Marketing	Advertising spread over more units
Risk-bearing	Many products and markets

Internal diseconomies: poor communication, slow decisions, low motivation, coordination problems.

External economies (all firms in the industry gain): skilled labour pool, specialist suppliers, better transport, shared training.

External diseconomies: congestion, higher rents and wages, strain on local services.

Reading a cost table. Work out average cost for each row, then look for where it stops falling.

Output	Total cost	Average cost
100	4,000	40
200	6,000	30
300	7,800	26
400	10,400	26
500	14,000	28

Average cost falls to 26 (economies), stays at 26 between 300 and 400, then rises to 28 at 500 (diseconomies). The rise from 26 to 28 is (28 / 26 - 1) x 100 = 7.7%. The lowest-cost output is 300 to 400 units.

Internal or external? Ask whether the saving comes from this firm getting bigger (internal) or from the industry around it growing (external).

Evaluation chains

Use a chain of reasoning, then a judgement.

• Horizontal merger: larger firm, so more output and bulk buying, so lower average cost; but fewer rivals can mean higher prices, and merging two cultures can slow decisions. The outcome depends on how much competition remains and how well the firms integrate.
• Conglomerate merger: spreads risk, so profits are steadier; but managers who do not know the new industry may make poor decisions. It suits a firm with strong management and spare funds.
• Small firm survival: a niche or local market protects a small firm from large rivals; but with weak bargaining power and limited finance it can fail in a downturn. How well it survives depends on how special its product is.
• Growth route: internal growth is slower but safer; external growth is quicker but costly and riskier. A firm with cash and a clear plan may choose a merger; a cautious firm may prefer organic growth.

Method for a merger scenario

1. Identify the stage of production of each firm from the information given.
2. Name the type: same industry and same stage is horizontal, same industry and different stage is vertical, unrelated industries is conglomerate.
3. For backward or forward vertical, say which way the buyer moves along the supply chain.
4. Give one benefit, linked to the firms in the question.
5. Give one drawback or risk, linked to the same firms.
6. Finish with a judgement and a reason, such as “the merger is more likely to succeed if the two firms share similar working methods”.

Must-know distinctions

• Merger (two firms join) versus internal growth (one firm expands).
• Backward versus forward vertical.
• Horizontal (same stage) versus conglomerate (unrelated).
• Internal economies (firm size) versus external economies (industry size).
• Market share (a percentage of the market) versus sales (an amount).
• Private sector (owned privately) versus public sector (government-owned), which is not the same as small or large.

Quick self-test

1. Name the sector of a coastal fishing business.
2. Define public sector.
3. A firm sells 2.7 million in a market worth 18 million. Calculate its market share.
4. Firm M has turnover of 540,000 and 12 employees. Calculate turnover per employee.
5. State one reason a small firm may survive next to large rivals.
6. Classify a furniture maker buying a chain of furniture shops.
7. Classify a bank group buying a farm.
8. A firm’s average cost falls from 30 to 20 when output doubles. Calculate the percentage fall and name the effect.
9. Name one internal economy and one external economy of scale.
10. Sales rise 10% in a market that grows 20%. Does market share rise or fall?
11. Give one internal diseconomy of scale.
12. State one advantage and one disadvantage of external growth.

Answers

1. Primary.
2. Firms owned and run by the government.
3. 2.7 / 18 x 100 = 15%.
4. 540,000 / 12 = 45,000.
5. Any one: personal service, niche market, little scope for scale economies in the industry, local demand.
6. Forward vertical merger.
7. Conglomerate merger.
8. (20 / 30 - 1) x 100 = -33.3%, a 33.3% fall; economies of scale.
9. For example bulk buying (internal); a pool of skilled workers in the area (external).
10. Fall: 1.10 / 1.20 is less than 1.
11. For example slow decisions or poor communication.
12. Advantage: faster growth, or quick access to a new market. Disadvantage: high cost, or culture clash and job losses.

Where marks are usually lost

• Naming a sector without linking it to what the firm actually does.
• Giving the advantages of a small firm in general terms with no link to the business in the question.
• Treating private sector as the same as small, or public sector as the same as large.
• Mixing up horizontal and vertical when a merger scenario describes suppliers and customers.
• Saying “economies of scale mean more profit” instead of lower average cost.
• Giving an internal economy when asked for an external one.
• Describing a merger’s benefits only, with no disadvantage or judgement.
• Working out market share using the wrong total (the firm’s own sales, not the market).
• Writing a percentage change the wrong way round.

Official syllabus

Cambridge IGCSE Economics 0455 syllabus for examination in 2026, version 2, Cambridge Assessment International Education, section 3.5 (Firms).