Reasons for the survival of small firms

Growth and Survival of Firms – Reasons for the Survival of Small Firms (Topic 7.7)

1. AS‑Level Foundations (Topics 1‑6)

Before tackling A‑Level material, students must be comfortable with the core micro‑ and macro‑economic ideas covered in the AS‑Level syllabus. A quick recap helps to see how these ideas feed into the discussion of firm survival.

AS Topic	Key Concepts	Typical Diagram
1 – Basic Economic Ideas	Scarcity, choice, opportunity cost, factors of production, economic problem.	Production Possibility Frontier (PPF)
2 – Micro‑Price System	Demand & supply, price elasticity, consumer & producer surplus, market equilibrium.	Demand‑supply curve, elasticity diagram
3 – Government Intervention (Micro)	Taxes, subsidies, price controls, regulation, market failure (externalities, public goods).	Tax incidence, subsidy impact diagrams
4 – Macro‑Economy (Basic)	Aggregate demand & supply, inflation, unemployment, fiscal & monetary policy basics.	AD‑AS diagram
5 – International Issues (Basic)	Trade balance, exchange rates, protectionism, benefits of trade.	Imports‑exports diagram, exchange‑rate graph
6 – Development & Growth	Factors influencing economic development, role of institutions, sustainable growth.	Growth‑rate diagram

2. A‑Level Topic 7 – Core Concepts Required for 7.7

2.1 Utility & Indifference Curves

• Marginal utility (MU) falls as consumption rises – the law of diminishing marginal utility.
• Indifference curves (IC) show combinations of two goods giving the same satisfaction.
• Budget line (BL) represents income‑constraint; the optimal choice is where the highest IC is tangent to the BL (MU₁/P₁ = MU₂/P₂).

2.2 Market Failure & Government Failure

• Externalities – positive (e.g., R&D spill‑overs) and negative (e.g., pollution). Government can internalise via taxes/subsidies.
• Public goods – non‑rival, non‑excludable; market under‑provides them.
• Information asymmetry – adverse selection, moral hazard; can be reduced by regulation or certification.
• Government failure – when intervention creates inefficiency (e.g., rent‑seeking, bureaucratic delay).

2.3 Cost‑Revenue Theory

• Short‑run cost curves: TC = TFC + TVC; AVC, AFC, ATC, MC.
• Long‑run: firms can vary all inputs; LRAC shows economies of scale, constant returns, diseconomies.
• Profit maximisation: produce where MR = MC; break‑even where TR = TC.
• Diagram suggestion: MR‑MC curve with ATC and AR (price) to illustrate profit, loss, and break‑even points.

2.4 Market Structures (Topic 7.6)

• Perfect competition – many price‑taking firms, homogeneous product.
• Monopolistic competition – many firms, differentiated products, free entry/exit.
• Oligopoly – few dominant firms, strategic interaction, possible collusion.
• Monopoly – single seller, barriers to entry, price‑setter.

2.5 Firm Objectives (Topic 7.8)

• Profit maximisation, revenue maximisation, growth, market share, survival, corporate social responsibility.
• Small‑firm owners often weight survival and growth higher than short‑run profit maximisation.

3. Reasons for the Survival of Small Firms (Topic 7.7)

3.1 Internal (Organic) Factors

• Entrepreneurial drive & flexibility – owners can make rapid decisions without layers of bureaucracy.
• Niche expertise – specialised knowledge of a product, service or local market creates a barrier to larger rivals.
• Cost control & low overheads – profitability achievable at lower sales volumes.
  Profit equation: $$\pi = TR - TC$$
  Marginal condition: MR = MC.
• Owner‑manager commitment – personal capital, reputation and time invested increase perseverance.
• Innovation & adaptability – ability to experiment with new processes, products or marketing approaches.

3.2 External (Environmental) Factors

• Market niche or local monopoly – serving a defined geographic area or specialised segment reduces direct competition.
• Supportive government policies (Topic 8):
  • SME tax reliefs (e.g., reduced corporation‑tax rates for turnover < £5 m).
  • Grants, subsidised advisory services (e.g., UK “Business Growth Programme”).
  • Regulatory relief – lighter health‑and‑safety reporting for firms below a size threshold.
  Evaluation: Improves cash flow and encourages investment, but may create dependency or distort competition if withdrawn.
• Access to finance (Topic 9.4):
  • Bank loans & micro‑finance.
  • Venture capital, angel investors.
  • Crowdfunding platforms.
  Link to macro‑policy: Higher interest rates raise the cost of borrowing, potentially curbing SME expansion.
• Supplier & customer relationships – personal ties provide reliable credit, repeat business and market intelligence.
• Economic cycles – downturns can force large firms to cut back, opening opportunities for agile small firms.

3.3 Strategic Choices (Growth & Survival Strategies)

1. Differentiation – unique features, superior service or strong branding; enables premium pricing.
2. Cost leadership in a niche – maintaining low average cost while serving a well‑defined segment.
3. Strategic alliances & networks – sharing resources, distribution channels or technology without losing independence.
4. Diversification – adding related products/services (e.g., a bakery offering catering) to spread risk.
5. Focus on quality & reputation – builds trust, repeat purchases and can act as a barrier to entry.

3.4 Types of Growth

3.4.1 Internal (Organic) Growth

• Product development – new or improved products (e.g., a craft brewery launching a seasonal ale).
• Market penetration – increasing sales of existing products in current markets (e.g., intensive local advertising).
• Vertical integration (backward/forward) – controlling more of the supply chain (e.g., a furniture maker purchasing its own timber).

3.4.2 External (Integration) Growth

• Horizontal integration – merging with/acquiring a direct competitor (two neighbourhood coffee shops forming a small chain).
• Vertical integration – acquiring a supplier or distributor (a boutique clothing label buying a fabric mill).
• Conglomerate integration – entering unrelated industries (a family‑run bakery purchasing a local gym).

3.4.3 Cartels (Limited Relevance to Small Firms)

• Definition: Agreement between firms in the same market to fix prices, limit output or share markets.
• Conditions for effectiveness: Few firms, homogeneous product, ability to monitor compliance.
• Welfare effects: Consumer surplus falls, producer surplus rises, dead‑weight loss is created.
• Legal status: Illegal in most jurisdictions because they restrict competition.

3.4.4 Principal‑Agent Problem

• Nature of the problem: Owners (principals) and managers (agents) may have divergent objectives.
• Agency costs: Monitoring costs, bonding costs, residual loss.
• Typical conflicts for SMEs: Managers may pursue rapid growth for personal prestige while owners prefer steady profit.
• Mitigation: Performance‑related pay, stock options, regular reporting, board oversight.

4. Linking Survival Strategies to Market Structure (Topic 7.6)

Market Structure	Typical Small‑Firm Survival Strategy	Why It Works
Monopolistic competition	Differentiation & brand building	Products are close substitutes; uniqueness attracts loyal customers and allows some price‑setting.
Oligopoly	Niche focus & strategic alliances	Large rivals have high barriers; small firms survive by serving specialised segments or cooperating to achieve economies of scale.
Perfect competition	Cost leadership & operational efficiency	Firms are price‑takers; survival depends on minimising average cost (ATC) to stay above the market price.
Monopoly (local monopoly)	Local market dominance & strong customer relationships	Absence of close rivals gives price‑setting power and the ability to earn economic profit.

5. Government Micro‑Intervention (Topic 8)

Micro‑level policies directly affect the operating environment of small firms.

• Taxes & subsidies – reduced corporation‑tax rates, R&D tax credits, wage subsidies.
• Price controls – minimum wages (affect labour costs), rent caps (affect premises costs).
• Regulation – health & safety, environmental standards; “lighter‑touch” regimes for SMEs.
• Support programmes – business advisory services, export promotion agencies, incubators.

Evaluation tip for exams: Weigh the efficiency gains (e.g., lower compliance costs) against possible market distortions (e.g., reduced competition, fiscal burden).

6. Macro‑Economic Links (Topic 9)

Small‑firm survival does not occur in a vacuum; macro‑variables shape the strategic landscape.

• Aggregate demand (AD) shifts – A rise in AD raises output and may increase demand for SME goods and services.
• Multiplier effect – Investment in a small firm (e.g., a government grant) can generate a multiplied increase in national income.
• Monetary policy – Lower policy rates reduce borrowing costs, encouraging SME expansion; higher rates have the opposite effect.
• Fiscal policy – Targeted tax credits or accelerated depreciation for capital equipment boost SME investment.
• Unemployment – High unemployment can provide a flexible, low‑cost labour pool for expanding firms.

7. Government Macro‑Intervention (Topic 10)

• Supply‑side policies – Skills training, infrastructure investment, and deregulation that improve productivity of SMEs.
• Fiscal incentives – R&D tax relief, capital allowances, and “small‑business rate relief” on commercial property.
• Monetary tools – Special SME loan schemes (e.g., central‑bank guaranteed credit lines) and lower reserve requirements for banks that lend to small firms.
• Evaluation: While these policies can raise the long‑run growth potential, they risk fiscal pressure and may favour certain sectors over others.

8. International Issues & Development (Topic 11)

Globalisation creates both opportunities and threats for small firms.

• Export opportunities – Niche products can find overseas markets via e‑commerce platforms (e.g., handmade jewellery sold on Etsy).
• Import competition – Low‑cost imports can erode market share; firms may need to improve quality or differentiate.
• Exchange‑rate movements – A weaker domestic currency makes exports more competitive but raises the cost of imported inputs.
• Trade agreements – Preferential tariffs for SMEs in certain sectors (e.g., the EU “SME‑friendly” rules of origin).
• Development perspective – In developing economies, SMEs are often the main engine of employment and poverty reduction; government support is therefore a key development policy.

9. Summary Table of Key Survival Factors

Category	Key Factor	Impact on Survival
Internal	Entrepreneurial flexibility	Quick response to market changes and new opportunities.
Internal	Niche expertise	Creates a barrier to entry for larger rivals.
Internal	Low overheads & cost control	Allows profitability at lower sales volumes.
External	Local market dominance	Reduces competitive pressure; enables price‑setting.
External	Government support (tax relief, grants)	Improves cash flow and lowers effective cost of capital.
External	Access to finance	Facilitates investment in growth‑enhancing assets.
Strategic	Differentiation	Allows premium pricing and builds customer loyalty.
Strategic	Alliances & networks	Provides economies of scale and market access without loss of independence.
Growth	Organic product development	Expands revenue while retaining control.
Growth	Vertical integration	Reduces dependence on external suppliers and improves margins.
Governance	Mitigating principal‑agent problem	Aligns manager incentives with owner objectives, reducing inefficiency.
Macro	Favourable monetary & fiscal environment	Low interest rates and targeted tax incentives stimulate SME investment.
International	Export niche & e‑commerce	Opens new markets, diversifies revenue streams.

10. Diagram Suggestions for Revision

• Flowchart: Show the interaction between internal factors, external conditions, strategic choices, and the two growth routes (organic vs. integration) leading to “Survival of Small Firms”.
• MR‑MC with ATC: Illustrate profit, loss and break‑even points for a typical SME.
• AD‑AS impact: Demonstrate how a fiscal stimulus targeted at SMEs shifts AD and influences output and price level.
• Supply‑side policy diagram: Link infrastructure investment to lower LRAC for small firms.
• Export‑import balance: Show how exchange‑rate changes affect a small exporter’s revenue and cost of imported inputs.

11. Concluding Remarks for Exam Preparation

To score well in the Cambridge International AS & A Level Economics exam, students should be able to:

1. Recall and briefly explain the AS‑Level foundations (Topics 1‑6) that underpin the discussion of firm survival.
2. Define and illustrate the key A‑Level concepts (utility, market failure, cost‑revenue theory, market structures, firm objectives) that are directly linked to 7.7.
3. Identify internal, external and strategic factors that help small firms survive; evaluate each with at least one real‑world example.
4. Explain how different market structures influence the choice of survival strategy.
5. Discuss the role of government – both micro‑ and macro‑intervention – and assess the likely effectiveness and possible side‑effects.
6. Show understanding of the macro‑economic context (AD‑AS, multiplier, monetary/fiscal policy) and of international issues (exchange rates, trade agreements) as they relate to SMEs.
7. Use appropriate diagrams to support explanations and to demonstrate analytical skills.

Mastering the connections between these sections will enable students to answer both knowledge‑based and evaluative questions with confidence.