Private sector/public sector firms

Micro‑Economic Decision‑Makers – Firms

Learning Objective

Explain the differences between private‑sector and public‑sector firms, describe the main types of firms, compare small and large firms, outline mergers, economies and diseconomies of scale, define the key cost and revenue concepts, list the objectives that firms may pursue, and compare the two main market structures (perfect competition and monopoly).

Key Definitions

• Firm: An organisation that combines factors of production to produce goods or services for sale.
• Private‑sector firm: Owned by individuals, families, partnerships or shareholders; operates primarily for profit.
• Public‑sector firm (state‑owned enterprise): Owned and controlled by the government; may pursue profit, but also social, political or policy objectives.
• Primary, secondary and tertiary firms:
  • Primary: Extracts natural resources (e.g., a coal mine, a fishing fleet).
  • Secondary: Manufactures or processes raw materials into finished goods (e.g., a car factory, a textile mill).
  • Tertiary: Provides services rather than tangible goods (e.g., a bank, a supermarket, a hospital).

Classification of Firms

Sector	Ownership	Typical Objective(s)	Examples
Private‑sector (primary, secondary, tertiary)	Individuals, families, shareholders, partnerships	Profit maximisation (often also growth or survival)	Tesco (retail), BP (energy), Samsung (electronics)
Public‑sector (state‑owned)	Central, regional or local government	Social welfare, universal service provision, employment, price stability	BBC, NHS, Kenya Power

Characteristics of Private‑Sector Firms

1. Ownership is private – individuals, families, shareholders.
2. Primary objective is profit maximisation (often complemented by growth or survival).
3. Financed through:
   • Owner’s capital (equity)
   • Bank loans (debt)
   • Shares issued on stock markets
4. Decision‑making driven by market signals (price, cost, demand).
5. Subject to competition; free entry and exit.

Characteristics of Public‑Sector Firms

1. Owned and controlled by the government (central, regional or local).
2. Objectives may include:
   • Provision of essential services
   • Employment creation
   • Price stability for consumers
   • Social welfare and equity
3. Financed through:
   • Tax revenue
   • Government borrowing
   • Subsidies and grants
4. Decision‑making influenced by political considerations and policy goals.
5. Often protected from direct competition (monopolies or heavily regulated markets).

Small vs. Large Firms (Advantages & Disadvantages)

Aspect	Small Firm	Large Firm
Flexibility	High – can adapt quickly to market changes.	Lower – bureaucratic procedures slow response.
Access to finance	Limited – rely on owner’s capital or small loans.	Broad – can issue shares, obtain large bank loans.
Economies of scale	Few – higher average costs.	Many – lower average costs, bulk buying.
Market power	Very little – price taker.	Potentially significant – can influence price (especially in monopoly/oligopoly).
Management	Owner‑managed – close control.	Complex hierarchy – risk of coordination problems (diseconomies of scale).

Types of Mergers

Mergers combine two or more firms to form a larger entity. The three main types are:

• Horizontal merger: Between firms that produce the same (or very similar) products and operate at the same stage of production. Example: British Airways merging with Iberia.
• Vertical merger: Between firms at different stages of the production chain (e.g., a manufacturer and its supplier). Example: A car maker acquiring a tyre manufacturer.
• Conglomerate merger: Between firms that have no common production processes or markets. Example: A food company acquiring a telecommunications firm.

Economies and Diseconomies of Scale

• Economies of scale: Average total cost (ATC) falls as output increases because fixed costs are spread over more units and/or technical efficiencies are achieved.
  • Internal economies – larger plant, specialised labour, bulk buying, better use of machinery.
  • External economies – industry‑wide improvements such as better infrastructure, skilled local labour pool.
• Diseconomies of scale: ATC rises when output continues to increase, often due to management difficulties, worker demotivation, or coordination problems.

Cost and Revenue Concepts

Concept	Definition	Formula (where applicable)
Total Revenue (TR)	Money received from sales of output.	TR = P × Q
Average Revenue (AR)	Revenue per unit of output.	AR = TR / Q = P
Total Cost (TC)	All costs incurred in producing a given level of output.	TC = FC + VC
Fixed Cost (FC)	Costs that do not vary with output (e.g., rent, salaries of permanent staff).	–
Variable Cost (VC)	Costs that vary directly with output (e.g., raw materials, hourly wages).	–
Average Total Cost (ATC)	Cost per unit of output.	ATC = TC / Q
Average Fixed Cost (AFC)	Fixed cost per unit of output.	AFC = FC / Q
Average Variable Cost (AVC)	Variable cost per unit of output.	AVC = VC / Q
Marginal Cost (MC)	Extra cost of producing one more unit.	ΔTC / ΔQ
Marginal Revenue (MR)	Extra revenue from selling one more unit.	ΔTR / ΔQ

Typical Firm Objectives (Cambridge Requirement)

1. Survival – staying in business.
2. Profit maximisation – highest possible profit.
3. Growth – increasing size, market share or output.
4. Social welfare – providing services at affordable prices (more common for public‑sector firms).

Decision‑Making in Private‑Sector Firms

Private firms aim to maximise profit (π):

$$\pi = TR - TC$$

Profit is maximised where marginal revenue equals marginal cost:

$$MR = MC$$

Key steps in the decision‑making process:

1. Estimate market demand and price elasticity.
2. Calculate expected total revenue: $TR = P \times Q$.
3. Identify the cost structure (fixed vs variable) and compute MC.
4. Adjust output until $MR = MC$.
5. Take account of any additional costs (taxes, interest) and decide on the final output level.

Decision‑Making in Public‑Sector Firms

Public firms balance several objectives, often expressed as a weighted function:

$$\max \; W = \alpha \times \text{Social Welfare} + \beta \times \text{Employment} + \gamma \times \text{Revenue}$$

where $\alpha$, $\beta$ and $\gamma$ reflect the relative importance placed on each goal by the government.

Typical considerations include:

• Ensuring universal access to essential services (e.g., water, electricity).
• Keeping prices affordable for low‑income households.
• Maintaining employment in strategic sectors.
• Operating within a budget set by the treasury.

Market Structures (Required by the Syllabus)

Feature	Perfect Competition (Competitive Market)	Monopoly
Number of sellers	Many small firms	One firm
Product type	Homogeneous (identical)	Unique product, no close substitutes
Entry/exit	Free – no barriers	Barriers (legal, technical, natural)
Price‑setting power	None – price taker (price = MR = AR)	Price maker – chooses price; MR < Price
Efficiency	Allocative (P = MC) and productive (P = minimum ATC) efficiency	Usually allocative inefficiency (P > MC) and possible productive inefficiency
Typical examples	Market for wheat, local hairdressers	State‑owned utilities, local water supply

Examples of Firms

• Private‑sector: Tesco (retail – tertiary), BP (energy – secondary), Samsung (electronics – secondary).
• Public‑sector: BBC (broadcasting – tertiary), NHS (health – tertiary), Kenya Power (electricity – secondary).

Suggested Diagrams for Revision

• Profit‑maximising output for a private firm where MR = MC (show MR, MC and profit rectangle).
• ATC curve illustrating economies of scale followed by diseconomies of scale.
• Comparison of output decisions: private firm (profit focus) vs public firm (weighted objective function).
• Perfect‑competition firm diagram (price taker) and monopoly diagram (price maker, MR curve).

Summary

Private‑sector firms are owned by individuals or shareholders, aim primarily at profit maximisation, raise finance from private sources and respond directly to market forces. Public‑sector firms are owned by the government, pursue a range of social and economic objectives, are funded through taxation and borrowing, and their decisions are shaped by policy rather than pure market signals. Small firms are flexible but lack economies of scale; large firms enjoy lower average costs but may suffer coordination problems. Understanding these motivations, constraints, and typical market environments is essential for analysing how markets operate and the role of government in the economy.