Pearson Edexcel IAL Economics: Types, growth and objectives of businesses (YEC11) – Revision Notes

Condensed notes for the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (Issue 2, June 2018), section 3.3.1, items 1 to 3. This is Unit 3 content, which the specification labels an IAL compulsory unit: it sits in the full International A Level (the extra A2 units), not the International AS. For explanations and fuller worked examples, read the study guide. When you are ready, try the practice set, the free diagnostics and the course checklist. The course hub has the rest of the course. All data here are invented.

1. Types of business (item 1a)

Type	Key point	Typical aim
Private sector	Owned by individuals or shareholders	Profit or return to owners
State-owned (public sector)	Owned by government	Public service, jobs, correcting market failure
For-profit	Surplus goes to owners	Distribute profit
Not-for-profit	Surplus reinvested in the purpose	Social or charitable aim
Co-operative	Owned by members (workers, consumers or suppliers), often one member one vote	Member benefit
Joint venture	Two or more firms share a project, costs and risks	Entry to markets, shared expertise

State-owned enterprises: may pursue public interest goals, fund loss-making but socially valuable services and keep essential industries under public control. Weaknesses: weaker cost discipline, political interference and reliance on taxpayers. Private sector firms face competitive pressure and profit incentives, but may ignore external costs and unprofitable customers.

Co-operatives: members share profit and decisions, which builds loyalty. Raising capital is harder because outside investors get no control. Joint ventures: each partner contributes assets or skills. They end when the project ends or one partner buys the other out.

Must-know distinction: a not-for-profit body may earn a surplus. The question is where the surplus goes.

2. Size and growth (items 2a to 2g)

• SME or large: state the measure (employees, turnover or assets). Definitions differ between countries.
• Organic growth: growth from within, funded by retained profit. Slow, low risk, control kept.
• Merger: agreed combination. Takeover: purchase of control, agreed or hostile.

Integration	Direction	One advantage	One disadvantage
Horizontal	Same stage, same industry	Economies of scale, market share	Regulator, job cuts
Forward vertical	Towards customers	Secures outlets and the retail margin	Unfamiliar skills
Backward vertical	Towards suppliers	Secure inputs, lower costs	Complacent in-house supplier
Conglomerate	Unrelated industry	Spreads risk	No synergies, loss of focus

Constraints on growth: size of market; access to finance; owner objectives; government regulation and bureaucracy.

Why firms stay small: niche or local demand, personal service, flexibility, owner choice, lack of finance. Why firms grow: economies of scale, market power, diversification, survival, manager or shareholder pressure.

Impact of growth: businesses gain scale but may suffer diseconomies. Workers gain security and promotion, or lose jobs after mergers. Consumers gain if cost savings are passed on, and lose if market power lifts prices or cuts choice.

Demergers: reasons are diseconomies of scale, refocusing on core activities, raising cash, releasing hidden value and regulation. Impact: sharper focus, lost scale economies, uncertainty for workers, uncertain effects on prices and choice.

Merger arithmetic reminders

Measure	Formula	Illustration (invented)
Market share	firm sales / market sales × 100	30 / 200 = 15%
Merged share	(sales A + sales B) / market × 100	(30 + 20) / 200 = 25%
Percentage growth	change / original × 100	(3.0 − 2.5) / 2.5 = 20%
Takeover premium	(offer − market price) / market price × 100	(5.50 − 4.00) / 4.00 = 37.5%
Cost saving	combined costs before − costs after	9.0 + 6.0 − 12.0 = £3.0m
Vertical saving	(supplier price − in-house cost) × volume	(8.00 − 6.50) × 100,000 = £150,000

Always write the unit and say what the base is. In a percentage change question the base is the starting figure; in a share question it is the whole market.

Method for evaluating a merger (steps)

1. Name the type and the motive.
2. Chain the gain: lower unit costs, then lower prices only if competition forces a pass-on.
3. Chain the harm: market power, higher prices, job losses.
4. Judge with a condition: market contestability, regulator, size of the savings.

3. Objectives (items 3a to 3c)

Objective	Condition	Formula
Profit maximisation	MC = MR, MC cutting MR from below	Profit = TR − TC
Revenue maximisation	MR = 0	TR = P × Q
Sales volume maximisation	Largest Q where AR ≥ AC	AR = AC at the limit

At maximum revenue, price elasticity of demand equals 1 for a straight-line demand curve.

Worked reminder. A printer faces P = 66 − 3Q, with Q in thousands and money in £000. Total cost is TC = 20 + 12Q + 1.5Q², so MR = 66 − 6Q and MC = 12 + 3Q.

Q	P	TR	TC	Profit	MR	MC
5	51	255	117.5	137.5	36	27
6	48	288	146.0	142.0	30	30
7	45	315	177.5	137.5	24	33
11	33	363	333.5	29.5	0	45

• Profit maximum: 66 − 6Q = 12 + 3Q, so Q = 6, P = 48, profit £142k.
• Revenue maximum: MR = 0, so Q = 11, P = 33, TR £363k, profit £29.5k.
• Sales volume maximum with no loss: 4.5Q² − 54Q + 20 = 0 gives Q ≈ 11.6, P ≈ 31.1, profit zero.

Pattern: output rises and price falls as you move from profit to revenue to sales volume.

Satisficing: managers aim for acceptable profit, sales and staff satisfaction, not the maximum. With a profit target of £100k or more, output from about 3 to 9 thousand units qualifies (profit is £101.5k at 3 and £101.5k at 9).

Principal-agent problem: owners (principals) and managers (agents) have different aims, and managers know more (asymmetric information). Managers may chase revenue, growth, pay or status.

Fix	Limit
Profit-related pay, share options	Short-termism, manipulation of results
Independent directors, audits	Cost of monitoring
Takeover threat	Only works if shares are widely traded

Worked chain: horizontal merger and consumers

Two rival bus companies merge. Cost chain: one head office and shared depots, so average cost falls, so the firm can cut fares. Harm chain: fewer rivals, so a higher market share, so more market power, so fares may rise and services on weak routes may be cut. Judgement: consumers gain only if rivals or new entrants keep the merged firm under pressure and the regulator watches fares.

Worked chain: demerger

A group that makes tools, toys and tiles struggles to manage three unrelated businesses. Managers lose focus, so costs rise and profit lags. After a demerger, each firm has a clear aim and its own management. The tile business is valued more highly and can raise finance easily. Workers may fear job losses in the old head office but may gain a clearer career path in the smaller firm.

Quick self-test

1. A charity-run shop reinvests its surplus. Is it for-profit or not-for-profit?
2. Name the type of integration when a brewer buys a chain of pubs.
3. Two firms sell £15m and £10m in a market worth £200m. What is the merged market share?
4. Revenue rises from £2.5m to £3.0m. Calculate the percentage growth.
5. A bidder offers £5.50 for shares trading at £4.00. Calculate the premium.
6. Give two constraints on the growth of a small firm.
7. Demand is P = 84 − 6Q. At what output is revenue maximised, and what is the price?
8. Using the same demand, find profit-maximising output if MC is constant at 12.
9. A firm’s revenue is £480k and its total cost is £350k. Calculate profit.
10. Explain in one sentence why a manager paid on sales may prefer a different output from the owners.

Answers

1. Not-for-profit.
2. Forward vertical integration.
3. (15 + 10) / 200 = 12.5%.
4. (3.0 − 2.5) / 2.5 = 20%.
5. (5.50 − 4.00) / 4.00 = 37.5%.
6. Any two: small market, difficulty raising finance, owner objectives, regulation or bureaucracy.
7. MR = 84 − 12Q = 0, so Q = 7 and P = 84 − 42 = 42. Revenue is £294.
8. MR = 84 − 12Q = 12, so Q = 6 (price 48).
9. 480 − 350 = £130k.
10. Pay linked to sales rewards extra revenue even if profit falls, so the manager pushes output beyond the owners’ preferred level.

Where marks are usually lost

• Describing a merger type without naming which stage of production the firms occupy.
• Saying growth lowers prices without explaining that cost savings must be passed on.
• Treating profit maximisation as the only objective and ignoring satisficing and the principal-agent problem.
• Stating MR = MC for every objective.
• Giving a one-sided answer on mergers, with no judgement on which effect is larger.
• Mixing up units or leaving out the unit (£, £000, thousands) in calculations.
• Using real firms as examples without applying economic concepts to them.
• Writing “not-for-profit” as “makes no money”.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics, specification Issue 2, June 2018, Pearson Education Limited: Unit 3, section 3.3.1, items 1 to 3.