What Are Some Various Constraints That Firms Face in Maximizing Their Economic Profit?
For-profit businesses exist to make money. The better a business is at determining a price point at which demand for its products is highest, the more it can maximize profits. In the process of trying to maximize profits, every business faces limitations or constraints, some of which the business can control and some it can't. A long-term approach to profit maximization can overcome many of these constraints.
Economic profits are not the same as monetary or accounting profits recorded in financial statements. In the equation “profit equals the difference between total revenues minus total costs,” accounting profits are determined by a quantitative assessment that considers the cost portion of the equation only in terms of money. Economic profit calculations substitute implicit and explicit opportunity costs in the cost portion of the profit equation. Opportunity costs are the consequences of choosing one option over another available option. For example, if the business lowers the price of a $15 item to $10 in order to get more customers in the door and sells 150 items in one week, it generates $1,500 in sales revenues. If average weekly sales for the item were 80 units or $1,200, the consequence of making the decision to reduce the price of the item is an economic profit is $300.
The limits of current technology constrain economic profits as well. Once a business reaches the limits of technology, increasing productivity and generating additional sales revenues requires more resources and as a result the business incurs additional costs. Assume, for example, your online business has reached its maximum server capacity and can only grow if you purchase another server and hire one additional employee. The expense you will incur increases costs and in this way places limits on or constrains profits that additional sales revenues will generate.
Consumer demand is essential for generating sales revenue dollars required to maximize profits. Budget or cash flow considerations and industry competition can both decrease demand and place constraints on economic profit maximization. Budget constraints can lead to lower quality products, less effective marketing campaigns or insufficient staff that can ultimately decrease demand. Industry competition can affect the business’s ability to attract new customers. This constrains demand for your products and places limits on sales revenue potential
The higher a business’s inventory costs, the higher prices must be to compensate, which further constrains economic profit maximization. This also brings an associated cost in the time it takes to negotiate with current suppliers, find new vendors and research options for reducing inventory costs. If you determine the business can qualify for deep discounts by purchasing inventory in bulk but need to create additional space to store the inventory, the money you save by purchasing inventory in bulk will be reduced by the cost to rent warehouse space.