Primary/secondary/tertiary sector firms

Micro‑economic Decision‑Makers – Firms

Learning Objective

Identify and describe the three economic sectors – primary, secondary and tertiary – and explain how firms in each sector make decisions about production, pricing and profit. In addition, understand the key concepts of production, factor demand, costs, revenue, objectives, market structures, workers, households and money & banking required by the Cambridge IGCSE 0455 syllabus (3.2‑3.7).

1. The Three Economic Sectors

2. Firms and Production (Syllabus 3.5)

2.1 Demand for Factors of Production

• Quantity of labour, capital, land and entrepreneurship a firm wishes to hire at given factor prices.
• Derived from the marginal product of each factor and the factor’s price (e.g., Wage = MPL × p_output).

2.2 Labour‑Intensive vs. Capital‑Intensive Production

2.3 Productivity

• Productivity = output per unit of input (e.g., units per worker‑hour).
• Higher productivity shifts the production function outward, allowing the same inputs to produce more output.
• Productivity improvements can arise from better training, superior technology or more efficient organisation.

2.4 Impact of Investment

• Investment in new plant, machinery or training changes the factor mix:

  • Increases capital intensity → higher fixed costs, lower variable costs per unit.
  • Raises productivity → factor‑demand curves shift left (less labour needed for a given output).

• In the short‑run, investment mainly affects the firm’s cost structure; in the long‑run it can alter the market’s supply curve.

2.5 Production Function (brief note)

The production function shows the maximum output (Q) that can be produced from given quantities of inputs. A rise in productivity or a successful investment moves the curve outward, indicating that more output can be obtained from the same input bundle.

3. Workers (Syllabus 3.3)

3.1 Wage Determination

• Demand for labour – derived from the marginal product of labour (MPL) and the price of output: Wage = MPL × p.
• Supply of labour – influenced by population, education, alternative employment, and willingness to work at different wages.
• Equilibrium wage is where the labour‑demand curve meets the labour‑supply curve.

3.2 Trade‑Union Influence

• Unions negotiate collective bargaining agreements that can raise the market‑determined wage.
• Resulting wage floor creates a “wage‑gap” above the equilibrium wage, potentially reducing employment (illustrated by a shift in the labour‑supply curve).

3.3 National Minimum Wage (NMW) Diagram (required by 3.3.2)

A horizontal line at the statutory minimum wage intersecting the labour‑demand curve shows the quantity of labour that firms are willing to hire at that legal floor. The area between the NMW line and the equilibrium wage represents the “unpaid” surplus for workers; the horizontal distance shows any unemployment created by the floor.

4. Money & Banking (Syllabus 3.4)

4.1 Functions of Money

• Medium of exchange – avoids the inefficiencies of barter.
• Store of value – preserves purchasing power over time.
• Unit of account – provides a common measure for pricing and accounting.

4.2 Role of Central and Commercial Banks

• Central bank (e.g., the Bank of England) controls the money supply, sets the policy interest rate, and acts as lender of last resort.
• Commercial banks accept deposits, provide loans, and create money through the fractional‑reserve system.
• Monetary policy (changing the policy rate) influences borrowing costs for firms, thereby affecting investment decisions and ultimately production.

5. Costs, Revenue and Objectives (Syllabus 3.6)

5.1 Cost Structure

5.2 Worked Example – Calculating ATC

Suppose a small bakery has FC = £500 per month. Variable cost per loaf = £1.20.

1. If the bakery produces 200 loaves:
   

   VC = £1.20 × 200 = £240
   

   TC = £500 + £240 = £740
   

   ATC = £740 ÷ 200 = £3.70 per loaf.

2. If output rises to 400 loaves:
   

   VC = £1.20 × 400 = £480
   

   TC = £500 + £480 = £980
   

   ATC = £980 ÷ 400 = £2.45 per loaf.

Notice how ATC falls as output increases – a typical illustration of economies of scale.

5.3 Revenue

• Total Revenue (TR): \$\text{TR}=p \times Q\$
• Average Revenue (AR): \$\text{AR}= \frac{\text{TR}}{Q}=p\$ (in a perfectly competitive market AR equals the market price).
• Marginal Revenue (MR): \$\text{MR}= \frac{\Delta \text{TR}}{\Delta Q}\$ – the extra revenue from selling one more unit.

5.4 Profit and Firm Objectives

• Profit (π): \$\pi = \text{TR} - \text{TC}\$
• Typical objectives (IGCSE may ask you to identify which a firm pursues):

  • Survival – covering all costs in the short‑run.
  • Profit maximisation – earning the greatest possible monetary profit.
  • Growth – expanding output, market share or product range.
  • Social welfare – providing a service for community benefit (common for public‑sector tertiary firms).

6. Decision‑Making Process

1. Estimate the expected revenue for each feasible output level.
2. Estimate the total cost for each output level.
3. Calculate profit (π = TR – TC) for each level.
4. Choose the output that gives the highest profit (or the least loss if profit is negative).

6.1 Profit‑maximising condition

A firm maximises profit where:

\$\text{MR} = \text{MC}\$

• In a perfectly competitive market, MR = p, so the rule simplifies to p = MC.
• In a monopoly, MR lies below the demand curve; profit is maximised where MR = MC, and the price is read from the demand curve at that output (so p > MC).

Note: The Cambridge syllabus states that diagrams are not required for 3.7, but a simple MR‑MC diagram helps visual learners to see the break‑even point, the profit area and the loss area.

7. Types of Markets (Syllabus 3.7)

8. Sector‑Specific Considerations

8.1 Primary sector firms

• Revenue is highly sensitive to world commodity prices (e.g., wheat, copper).
• Costs are affected by weather, disease, soil quality and extraction technology.
• Risk‑management tools such as futures contracts or forward selling are often used.

8.2 Secondary sector firms

• Economies of scale can lower ATC as output rises.
• Investment in plant and machinery influences both FC (depreciation) and VC (energy efficiency).
• Product differentiation may allow a firm to charge a price above MC.

8.3 Tertiary sector firms

• Quality of service, brand reputation and customer loyalty are key non‑price factors.
• Labour costs are often the largest variable cost.
• Pricing strategies may include price discrimination (e.g., student or senior discounts).

9. Example: Decision‑Making in a Tertiary Firm (Coffee Shop)

Assume a coffee shop sells each cup for £2.50. The shop estimates the following costs:

• Fixed Costs (rent, utilities) = £1,200 per month
• Variable Cost per cup (beans, milk, hourly wages) = £0.80

Break‑even quantity (Q_BE) where profit = 0:

\$\text{TR}=2.50Q\$

\$\text{TC}=1,200+0.80Q\$

\$\text{Set TR = TC:}\;2.50Q = 1,200 + 0.80Q\$

\$1.70Q = 1,200\$

\$Q_{BE}= \frac{1,200}{1.70}\approx 706\text{ cups per month}\$

The shop must sell at least 706 cups each month to cover all costs. Any sales beyond this point generate profit equal to the difference between price (£2.50) and AVC (£0.80) multiplied by the extra units sold.

10. Links to Other Micro‑economic Topics

10.1 Households (Syllabus 3.2)

Five main influences on household spending, saving and borrowing:

1. Income – higher disposable income raises consumption.
2. Interest rates – affect the cost of borrowing and the reward for saving.
3. Consumer confidence – optimism encourages spending; pessimism encourages saving.
4. Age – younger households tend to spend more; older households tend to save.
5. Cultural factors – traditions and social norms shape preferences (e.g., food, clothing).

These factors determine the demand curve that firms face in the product market.

10.2 Workers (already covered in section 3)

10.3 Money & Banking (already covered in section 4)

11. Summary Checklist

• Identify the sector a firm belongs to and list its main sources of revenue and cost.
• Explain the demand for factors of production and how productivity or investment shifts factor‑demand curves.
• Distinguish labour‑intensive from capital‑intensive production.
• Calculate total, average and marginal cost, as well as total and average revenue.
• State the firm’s possible objectives (survival, profit maximisation, growth, social welfare).
• Apply the profit‑maximising condition:

  • Competitive market – p = MC
  • Monopoly – MR = MC and set price from the demand curve.

• Consider sector‑specific factors that can shift revenue or cost curves (weather, technology, consumer preferences, etc.).
• Recall the wider micro‑economic context – households, workers, and the money‑banking system.
• Know that diagrams are not required for the market‑structure part of the syllabus, but a simple MR‑MC or NMW diagram can aid understanding.