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Why firms stay small or demerge

Explain why some firms stay small, why firms demerge, and who gains and loses from a demerger

Many firms stay small because of their market, their costs or their owners' choices

Some firms serve a market too small for a large firm: a village shop, a plumber covering one town, a maker of made-to-order furniture. Where the long-run average cost curve has a wide flat bottom, a small firm produces at the same average cost as a large one and can compete with it.

Small firms also find it harder to raise money. They rely on the owner's savings and on bank loans, while large firms can sell shares or bonds. And many owners stay small by choice, to keep control of the business or because it already earns what they want.

A long-run average cost curve with a wide flat bottomVertical axis: Average cost. Horizontal axis: Output. LRAC: an U-shaped curve. A point at C1 on the vertical axis and Q1 on the horizontal axis. A point at Q2 on the horizontal axis.Q1C1Q2LRAC
A small firm at Q1 and a larger firm at Q2 both produce at average cost C1, on the flat bottom of the curve.
Predict first

A very large firm splits into two separate firms, each making half its old output. What do you think happens to the average cost of producing that output?