3.5 Firms

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3.5 Firms

Understanding how firms classify, grow, and achieve efficiency

What You Need to Know

Firms can be classified by economic sector, ownership, and size
Small firms exist even in the presence of economies of scale, with distinct advantages and disadvantages
Firms grow internally (organic) or externally through mergers (inorganic)
Three types of inorganic growth: vertical, horizontal, and conglomerate integration
Economies of scale make production cheaper as firms get bigger; diseconomies of scale make it more expensive
External economies of scale benefit individual firms when their entire industry grows

1. Classification of Firms

Before we understand why firms behave differently or grow at different rates, we need a way to describe them. Economists classify firms using three main criteria: the economic sector they operate in, whether they are publicly or privately owned, and their relative size. This classification helps us compare firms and make predictions about their likely objectives and strategies.

The Three Economic Sectors

Every firm in the world operates in one of three economic sectors, depending on what it does with raw materials and labour:

Primary Sector

Firms involved in extracting or producing raw materials from the earth. Think: fishing, farming, mining, forestry, oil drilling. These firms work directly with nature. A good example is Tata Steel, which extracts iron ore and turns it into steel.

Secondary Sector

Firms that take raw materials and manufacture them into finished goods. They transform primary sector output. Car manufacturing, food processing, textiles, electronics assembly. A good example is Kellogg's, which takes raw grain and manufactures breakfast cereals.

Tertiary Sector

Firms that provide services rather than physical goods. Banking, education, tourism, retail, transport, healthcare. A good example is Expedia, which provides travel booking services.

Why Does This Matter for Exams?

Governments measure how developed an economy is by looking at the proportion of workers and GDP in each sector. Developed economies have more tertiary sector activity; developing economies still rely heavily on primary sector.

Two Key Metrics:

% of workers employed in each sector: In 2019, 84% of Singapore's workers were in the tertiary sector — a sign of a highly developed economy.
% of GDP generated by each sector: In 2021, 38% of Ethiopia's GDP came from primary sector activity — a sign of a developing economy still dependent on agriculture.

Which economic sector would a coffee plantation belong to, and why?

Public vs Private Sector

The second way to classify firms is by who owns and controls them:

Public Sector Firms

Owned and controlled by the government. Their primary goal is usually to provide a service to the public, not to maximise profit. They can operate at local level (e.g., Transport for London), regional level (e.g., Agricultural State Service in India), or national level (e.g., Caribbean Airlines).

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Also in the full note

2. Small Firms
3. The Growth of Firms
4. Economies & Diseconomies of Scale
What to Memorise
Concepts Checklist
Common Exam Mistakes & Mark-Scheme Traps
The Relative Size of Firms
Six Reasons Why Small Firms Exist

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3.5 Firms

3.5 Firms

What You Need to Know

1. Classification of Firms

The Three Economic Sectors

Public vs Private Sector

More Economics topics