A market constraint sometimes referred to as a negative externality, is a non-exogenous economic restriction set against the volume of a product or service which forces the industry to sell the item at a lower price or reduce the production volume. There are many kinds of market constraints. In a deflation market, a negative externality is a reduction in the demand for goods and services as a result of a rise in the value of money.
A price level constraint, sometimes called a price ceiling, is a constraint on price change that is imposed by a central body such as a government or a public authority. The most common form of market constraint is a quantity constraint, where a production quantity of a commodity is controlled in order to ensure the supply of a commodity at a particular price level. Note that a market constraint cannot be solved by marketing solutions, even though many people have tried to beat the competition by using social media marketing websites like StreamOz to lure customers away from competitors. Nonetheless, let’s take a look at the different types of market constraints.
An Example Of Market Constraint: Limited Demand
If a manufacturer produces a hydraulic wood splitter with the capacity of 100 cords and the demand for woodwork in his region is low, then he figures that it will cost him an absolute fortune to purchase and install a splitter and hire workers to operate it. To make up for this loss, he decides to sell 100 cords to a company in India, where he figures it will cost him half a million dollars to install and operate. While he can now sell all his cords at a profit, he faces a market constraint because there is no more demand for his product. What is needed is a way to increase the number of cords sold, thereby increasing his profits but still maintaining a price level that allows him to make a reasonable profit from his sales.
Not Enough Supply To Meet Demand
In an equity market, a market constraint could be described as a situation where demand exceeds supply. For example, when there are more houses built than people wishing to live in them, then prices will drop. The owner of a house who bought a large amount of property at a given rate of interest will find that he does not earn as much as he did when he had only one house to go to sleep in. In such cases, the smart money is in short-term investments.
Case Study: Firewood Business
When a firewood business is considering buying equipment that sells for a price of $1000, the owner figures that he will earn a profit of two hundred percent on his investment. Since he figures it will take him four years to pay back his loan, he sets the purchase price at one percent over the market value. He then expects to earn another four percent from his monthly sales of wood to his customers. By extension, he now invests two hundred percent of his current sales price in the machinery.
While these are all interesting considerations, let us take a closer look at this assumption. If we assume that this machine is capable of handling forty cords per day, we have doubled the number of cords he needs to keep splitting wood burning! Further, we must also assume that the firm’s capital stock is one dollar per cord or eight hundred dollars at the current exchange rate. The owner figures that he can earn two thousand dollars in profit per month by selling this unit. This gives us a market order of four dollars per cord. Is this a profitable situation?
Now let us suppose that the owner does not assume a price limit, but assumes a price elasticity, i.e., a floor price, on the effective capacity component of his sales formula. Under such a condition, the cost elasticity of demand is zero. His theoretical sale price is therefore set at the point where the marginal revenue per cord decreases to exactly zero, and sales cannot exceed the unit cost. We have now solved the problem of determining which of the following is not a viable assumption, but a market constraint, since neither is a price elasticity assumption a viable assumption.
If, on the other hand, we assume a price elasticity, the assumption still fails. For if demand is price elastic, then the cost of production is equal to the value of production multiplied by the ratio of actual output to demand, or, in other words, actual output divided by sales, or sales per unit. Under normal operating conditions, the firm cannot sell more than it produces and can sell nothing but its products, at a net value of zero. The firm therefore can sell whatever it wants, at whatever price it wishes to since it has unlimited potential for gain.
Assuming that a. effective capacity and b. effective capacity is both zero prices, then demand is essentially a market constraint since firms that have a lower potential for gain do not face a constraint. Therefore, firms with relatively greater potential for gain, i.e., prices above their value of production, may sell to the public. Since they do not face a constraint on their purchases, they do not face a market constraint. A market price, determined by demand, is a price, which to a certain extent is determined by the potential gain. The point here is that the potential gain is, so far as monetary instruments are concerned, the only constraint on demand. It can be overcome by setting a ceiling price equal to the value of production multiplied by its geometric mean.
