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Meaning and Types of Economic Organization

Updated on June 1, 2014

Meaning of Economic Organization

Economic Organization is the act of coordinating the other factors of production – land, labor and capital. Organization performs a very important function in modern production, which is carried on a large-scale. Organization is done by the entrepreneur. The entrepreneur may be described as the captain of industry. The economic development of many rich nations like the U.K. and the U.S.A was made possible only by the activities of the entrepreneurs. Sometimes the entrepreneur is also known as “organizer” or “undertaker”.

Types of Economic organization

Economic organization may be broadly classified into the following types:

1. Sole proprietorship (one-man business)

2. Partnership

3. The Joint Stock Company

4. Co-operative Organization

5. State Undertakings.

1. Sole Proprietorship

Sole proprietorship is the oldest form of business organization. It is a “one-man” business. ‘one-man business’ is still common in retail trade. Though the scale of production has increased after the Industrial Revolution, small-scale business still continues to be an important element in modern economic organization. In the ‘one-man’ business, a single person undertakes the risk of production. He owns capital and performs all the functions of an entrepreneur. ‘one-man’ business is carried on generally on a small scale. The ‘one-man’ business has some advantages and disadvantage.

Advantages

  1. The owner of the firm will take a lot of interest in it and he will make his business as efficient as possible because he will get all the profits for himself, as he is his own boss.
  2. He can take quick decisions. There is no need for him to consult anyone else for changing the policies of his firm. In addition, he can put into effect his decisions immediately.
  3. He can have personal supervision of all the work done in the firm. He will be in close touch with his employees and customers. Under such circumstances, there will be little scope for dispute between the labor and management.
  4. Since the scale of production is small under sole proprietorship, it is a convenient type of business to cater to local demands. Generally, under large-scale production, standardization of goods is the rule. Where variety is needed, ‘one-man’ business is an ideal form of business organization.

Disadvantages

  1. Since the sole proprietor will have a small amount of capital, it may be difficult for him to expand his business.
  2. Risk is great in the case of one-man business. In case there is a loss, it has to be borne entirely by one man.
  3. The success under sole proprietorship depends upon the ability of one man. But with his death, if he is not succeeded by equally efficient men, the business will come to an end. And best men are not always succeeded by men of ability.
  4. ‘One-man’ business will be unsuitable in the case of industries where large capital has to be sunk. (For example, the construction of railways)

2. Partnership

Partnership is a type of business organization where business is carried on by two or more men. Sometimes, the small business may expand to such an extent that it may be beyond the control of one man. For its further development more capital may be necessary. Since one man cannot provide all of it, he will take a partner or two. Thus, sometimes one-man business grows into partnership. But in the case of some firms, there will be partnership right from the beginning. In some partnerships, there will be a sleeping partner also. That is, suppose there are two men in a partnership. Of the two, one member simply provides some capital but will not take part in the actual running of the business. Such a partner is known as sleeping partner. The function of a sleeping partner is more or less similar to that of a shareholder in a Joint-Stock Company. A partnership is based on confidence and mutual trust. It has some advantages and disadvantages.

Advantages

  1. The risk in a partnership is not as great as under sole proprietorship. For, in the case of a loss, it will be borne by both the partners.
  2. Greater amount of capital will be available than under one-man business. For the borrowing capacity of a partnership firm will be greater that of one-man business.
  3. Management of the firm under partnership will be generally efficient. Suppose one man looks after production matters, the other man may look after the general administration of the firm.

Disadvantages

  1. There is unlimited liability. One of the partners may possess a high degree of efficiency. But if the other partner happens to be inefficient or a man of doubtful character, there will be a loss. Both the partners have to bear the losses irrespective of their ability or honesty.
  2. In a partnership, some of the innocent partners are often cheated by others.
  3. Like the sole proprietorship, even the partnership is not permanent. Partnership will come to an end with the death of one of the partners or if there is quarrel between the two partners.

3. The Joint Stock Company

The Joint Stock Company is the most important form of business organization in modern times. A Joint Stock Company is an Association of shareholders who subscribe to its capital, which is divided up into a large number of shares. The shares are usually of small value. Thus, an important feature of a Joint Stock Company is that people will provide the capital in varying amounts and receive shares in the profits in proportion to the amounts of money they have invested in the company. In this way, it will be possible to raise large sums of capital necessary for large-scale production. Since the capital of the company is contributed jointly by a large number of shareholder, it is called a Joint Stock Company.

A Joint Stock Company is started usually in the following manner. An entrepreneur plans a scheme of business and requests his friends to cooperate with him and promote the business. The small group of organizers are known as promoters.

The capital of a Joint Stock Company is divided into a number of small shares. There are three main types of shares. They are:

1. Preference shares

2. Ordinary shares

3. Deferred shares

Preference shareholders usually get a fixed rate of dividend and they are paid in full before the ordinary shareholders receive anything. In case, the company incurs losses and is about to be liquidated, the preference shareholders must be paid in full from the remaining capital of the company before others are paid. Ordinary shareholders get their dividends only after all other claims of the company have been met. Generally, the ordinary shares carry no fixed rate of dividend. In other words, the rate of dividend on the ordinary shares is uncertain. Deferred shares are generally held by the promoters. Whatever is left of the total profits, after paying to all other types of shareholders, goes to them. By this way, usually the promoters get a major share of the profits.

In addition to the issue of various types of shares, a company may also get capital by raising loans from the public. It gets the loan capital by the issue of debentures. Debentures are not shares. The holders of the debentures are not members of the company like the shareholders. They receive a fixed rate of interest whether the company makes profits or losses. The debentures are repayable after a fixed number of years.

In a Joint Stock Company, the shareholders bear the risk of uncertainty. They elect a Board of Directors to manage the affairs of the company. The Board of Directors in turn, elects, one among them as a Managing Director or appoint a General Manager from outside on salary. Usually he will look into the day-to-day administration of the company. The directors are those persons who hold a large number of shares.

Advantages

  1. An important advantage of a Joint Stock Company is that the liability of each shareholder is limited. It means the liability of the shareholder is limited to that amount of his share capital. In case the company runs into financial difficulties, the shareholder may lose only the amount equal to the value of his shares and nothing else. The rest of his property is free from any claims by the creditors of the company.
  2. The small amounts of the persons who are interested in investment are brought together and this helps in capital formation. By this way, large-scale operations are made possible. People with even small savings can become shareholders of a Joint Stock Company. So it promotes investment habit.
  3. Shares are easily transferable. If a shareholder is in need of money, he can sell his shares on the Stock Exchange market.
  4. The Joint Stock Company has more or less a permanent existence. It has a stable life for generations. Shareholders may change. But the company goes on forever so long as it is managed well.
  5. The Joint Stock system is attractive for those ordinary investors who do not want to take an active part in the management of business. It enables them to invest their capital in a number of Joint Stock Companies. By this way, risk is spread out. Risk is much less in a Joint Stock Company than in a single business. Apart from the above advantages, a Joint Stock Company enjoys the general advantages of large-scale production.

Disadvantages

  1. The shareholders do not take personal interest in the business. Often they live at a great distance from the business. As long as they get their normal dividends, they may not bother themselves to know what is actually going on in the company. In other words, they are indifferent to the administration of the company. If the directors happened to be corrupt and unscrupulous, the company would be ruined.
  2. The salaried managers will not take any personal interest in business. They are not interested in making innovations. Even if some managers are enterprising men, they are subject to the control of directors. This acts as a check on their enterprise.
  3. Quick decisions are not possible.
  4. Promoters and directors cannot be effectively controlled by the shareholders. Small investors have little control over the way in which their capital is used.

It should, however, be noted that in spite of some of its defects, the Joint Stock Company has become the most popular form of business organization in modern times. It has helped to a great extent in raising large sums of capital for large-scale production. Joint Stock System is very popular in the organized sector of our economy. There are joint stock banks, sugar mills, paper mills and so on in our country.

4. Cooperative Organization

Cooperation has become an important form of business organization since the last century. Cooperation has taken many forms. There are consumers’ cooperative, producers’ cooperatives, cooperative marketing societies and so on. In a consumers’ cooperative society, members cooperate as consumers. They buy goods at wholesale prices, sell them at the usual retail prices, and then distribute the profits of the society in the form of dividend on profits. In a producers’ cooperative, a number of people, usually workers, combine to produce a commodity and share the profits among themselves. Consumers’ cooperation has been more successful than all other forms of cooperation in many countries.

A cooperative society resembles a Joint Stock Company in one respect. The capital of a cooperative as well as a Joint Stock Company is supplied by a large number of persons who receive interest on other shares. But there are many important differences. For example, the profits of a Joint Stock Company are distributed in proportion to the value of shares held by a person. But the profits of a cooperative society are distributed according to the value of the purchases. Voting in a cooperative society is based on ‘one man-one vote’ principle, irrespective of the number of shares held by a person. Another important difference between the two is that members of a cooperative society are not permitted to sell their shares. But shareholders of a Joint Stock Company can sell their shares. Of course, members of a cooperative society can withdraw their capital from the cooperative society if they desire to do so.

Advantages

  1. It is based on the democratic principle of ‘one man-one vote’. In other words, it is based on the principle of equality. Each member of the cooperative society has only one vote irrespective of the number of shares held by him. “All for each and each for all” is the motto of cooperation.
  2. A cooperative society generally has a stable trade. For, all the members will be loyal to the society.
  3. Middlemen’s profits are eliminated. It is the presence of a large number of middlemen between producers and consumers that is largely responsible for the high prices of many goods.
  4. It is the middle way between capitalism and socialism. It has all the advantages of capitalism and socialism minus their disadvantages. In a cooperative society, private profit motive is eliminated and there is no conflict between labor and capital as under capitalism. In a socialist organization, individual freedom is restricted to some extent. Sometimes people will be compelled to do certain things. But in a cooperative organization, some of the democratic principles such as liberty and equality are preserved. Membership of a cooperative society is voluntary. There is no compulsion of any kind.

Disadvantages

  1. A majority of the members of the cooperative society lack business experience. So they do not know how to promote business in an efficient manner.
  2. It does not attract men of ability. The main reason is that the directors and other senior officers in cooperative societies are paid low wages in comparison with private firms. So they prefer to go to private firms.
  3. Risk taking is an important factor in modern economic organization and it is very essential for the promotion of business. But the members of the cooperative society are slow in taking risks.

5. State Undertakings

The modern State plays a greater role in the economic affairs of today than in the past. The State itself owns and manages many firms, which supply commodities and services to people. The State operates many public utilities such as post-offices and railways. It supplies electricity to people. The Industrial Policy of the Government determines the role of the State undertakings in the economic field. Generally, those industries, which are of importance to the country from the point of view of defense and strategy, will be under the control of the government. Sometimes, for starting certain industries, large amounts of capital might be necessary. And private individuals or companies might not be in a position to start such industries. In such cases, the State will undertake the work. Again, there are certain essential services. If they are provided by private companies, they will exploit the people by charging high prices. But State undertaking will provide them at nominal prices. Until recently public utilities such as post-offices were operating on the principle of “no loss, no profit.” But there has been a change of this policy in recent times. Nowadays, the government fixes the prices of the goods supplied by State undertakings in such a way that the profits from these undertakings have become an important source of revenue to the government.

The State undertakings have certain advantages and disadvantages. The main advantages are that they provide essential services to people at a cheap price, private profit is eliminated and large amounts of capital are available for them. Further, there are no wastes of competition and key industries of national importance will be in the hands of the State.

The main disadvantage of the State undertakings is that, the absence of personal interest and of competition in many fields make them inefficient. In the absence of competition, it is also not easy to judge the efficiency of most of the State undertakings.

© 2013 Sundaram Ponnusamy

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    • profile image

      Nwoha N. B 4 months ago

      Good work

    • jsthomas profile image

      Jonathan Thomas 5 months ago from Virginia

      great article

    • Venkatachari M profile image

      Venkatachari M 6 months ago from Hyderabad, India

      Very informative and great discussion. You described the economic organizations so clearly and vividly.

    • profile image

      mary okumu 6 months ago

      good notes

    • profile image

      Sabby 11 months ago

      Thank you! I've gather a lot of informations for my report :)