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Economic Constraints Factors & Examples

Jacob Meiners, Shawn Grimsley
  • Author
    Jacob Meiners

    Jacob Mainers has taught university humanities for over three years. They have a master’s degree in history from Princeton University.

  • Instructor
    Shawn Grimsley

    Shawn has a masters of public administration, JD, and a BA in political science.

Learn about economic constraints. Read a detailed definition of economic constraints, learn how constraints affect a business plan, and see examples of constraints. Updated: 05/11/2022

What are Economic Constraints?

Being a business owner can be rewarding, but every entrepreneur needs to weigh different limitations likely to affect a business before setting it up. One of the most common limitations in a business is economic constraints. The definition of economic constraints is any external economic influence on a business that is beyond the business's control. The main characteristic of economic constraints is that they are external. This means that they exist outside the internal business environment. Another characteristic is that the business has no control over them and must learn to live with them.

Economic constraints examples are inflation, interest rates, and unemployment rates. An increase in these rates will negatively affect a business. Inflation is a severe concern in business because it makes investment decisions harder and leads to cutbacks in customer spending, eventually reducing the profit margin of any business. An increase in unemployment is also a drawback to any business because it erodes the purchasing power of consumers. A high-interest rate is another economic constraint that can affect a business in two ways. First, consumers with bank debts will have less to spend because they have to pay more interest. Secondly, companies with existing loans may have no option but to increase the prices of their goods and services because they have to pay more interest.

Understanding these constraints for a business owner is an effective way of producing appropriate strategies to handle any situation that may arise abruptly. Hence, examining external factors is considered an essential task for a business. External factors are those circumstances, influences, or situations that a business cannot control. Understanding these factors can aid a business owner in making suitable adjustments to their marketing strategies and plans to make the environment more adaptable. One example of external factors is supply and demand. Supply and demand is an essential external factor because it determines the price level of products. This is because it operates on the principle that there is a price decrease for goods and services when supply exceeds demand. Consequently, when demand exceeds supply, there is a hike in the price of goods and services.

Definition of Economic Constraints

Economic constraints are a type of external constraint. An external constraint is some factor in a company's external environment that is usually out of the company's control. An economic constraint involves external economic factors that affect a company and are usually outside of its control. A company is influenced by both microeconomic and macroeconomic factors in its external environment.

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Macroeconomic Factors

The prefix "macro" indicates something that is generally big or large. Therefore, macroeconomic factors refer to factors that affect the whole broad economy of a region or country instead of a specific area. Macroeconomic factors are among the constraints that affect a business plan. Before starting a business, an entrepreneur writes down a business plan to consider the neutral, positive, and negative factors. Planning for macroeconomics factors is essential because they cause indirect and direct effects on business operations, revenues, and personnel.

Some of the macroeconomic factors that affect a business are:

  • Inflation: Inflation refers to a situation where there is an increase in the average cost of goods and services over some time. Inflation negatively impacts businesses by increasing raw material, stock, and employee costs (such as wages). Companies can cope with inflation by strengthening their pricing power. A business that must raise prices to cover the cost should use creative pricing methods like product unbundling and bundling, adding or reducing features, or using different pricing models for various products.
  • Unemployment Rate: Unemployment describes a situation in which an individual is actively seeking a job but cannot find one. Unemployment directly impacts a business and the economy. When there are high unemployment rates in a country, people spend less money, resulting in less contribution to the economy and to businesses. A company can deal with unemployment by collaborating with training and education providers to help individuals develop the skills needed to find work.
  • Interest Rate: An Interest rate is defined as the percentage of principal that the lender charges to a debtor. In business planning, an increase in interest rates impacts the owner's ability to grow the business. Increased interest rates affect daily financial business operations in two ways. First, long-term debts become more expensive and take longer to pay. Secondly, it becomes more difficult for small businesses to meet their financial obligations, like profits and expenses, if interest rates rise unexpectedly. Companies can cope with this constraint by considering alternative financial options. Previously, companies were restricted to traditional term loans from well-known banks, but there are now plenty of other options to choose from. Some of the new options include Small Business Administration (SBA) loans, equipment financing, invoice factoring, and merchant cash advances. Even though rates might go up with these options as well, they may prove to be better for certain businesses and might offer additional flexibility in meeting business needs.

Macroeconomic Factors

Macroeconomic factors are things that influence the entire economy and all of the participants. Examples of macroeconomic factors include tax rates, inflation rates, money supply, interest rates, currency exchange rates, unemployment rates, periods of high economic growth, and periods of economic contraction, such as recessions and depressions.

Let's look at how these macroeconomic factors may affect a business. If the unemployment rate is high, you can usually get cheaper labor, which will lower your cost of production. On the other hand, if unemployment is too high, your sales may suffer because people can't afford your products. If interest rates are low, money is cheap to borrow, and you can more easily finance new ventures. If interest rates are too high, financing may not be possible. High tax rates take money out of your pocket and your consumers' pocket that could be used either for investment or for purchases.

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Video Transcript

Definition of Economic Constraints

Economic constraints are a type of external constraint. An external constraint is some factor in a company's external environment that is usually out of the company's control. An economic constraint involves external economic factors that affect a company and are usually outside of its control. A company is influenced by both microeconomic and macroeconomic factors in its external environment.

Macroeconomic Factors

Macroeconomic factors are things that influence the entire economy and all of the participants. Examples of macroeconomic factors include tax rates, inflation rates, money supply, interest rates, currency exchange rates, unemployment rates, periods of high economic growth, and periods of economic contraction, such as recessions and depressions.

Let's look at how these macroeconomic factors may affect a business. If the unemployment rate is high, you can usually get cheaper labor, which will lower your cost of production. On the other hand, if unemployment is too high, your sales may suffer because people can't afford your products. If interest rates are low, money is cheap to borrow, and you can more easily finance new ventures. If interest rates are too high, financing may not be possible. High tax rates take money out of your pocket and your consumers' pocket that could be used either for investment or for purchases.

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Frequently Asked Questions

What is an example of a constraint?

Inflation is an example of a business constraint. It affects consumers' purchasing power as the price of goods and services rises. Inflation also affects the cost of borrowing.

What are the constraints of economic growth?

Constraints of economic growth refer to external economic limitations that affect a business and are out of its control. An example of a constraint on economic growth is poor microeconomic conditions. An unstable exchange rate affects business planning and makes the business decision-making process harder.

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