Constraints and the Theory of the Firm - Managerial Economics

Importance of Constrained Optimization in Managerial Economics

Managerial decisions are often made in light of constraints imposed by technology, resource scarcity, contractual obligations, laws, and regulations. To make decisions that maximize value, managers must consider how external constraints affect their ability to achieve organization objectives.

Organizations frequently face limited availability of essential inputs, such as skilled labor, raw materials, energy, specialized machinery, and warehouse space. Managers often face limitations on the amount of investment funds available for a particular project or activity. Decisions can also be constrained by contractual requirements. For example, labor contracts limit flexibility in worker scheduling and job assignments. Contracts sometimes require that a minimum level of output be produced to meet delivery requirements. In most instances, output must also meet quality requirements. Some common examples of output quality constraints are nutritional requirements for feed mixtures, audience exposure requirements for marketing promotions, reliability requirements for electronic products, and customer service requirements for minimum satisfaction levels.

Legal restrictions, which affect both production and marketing activities, can also play an important role in managerial decisions. Laws that define minimum wages, health and safety standards, pollution emission standards, fuel efficiency requirements, and fair pricing and marketing practices all limit managerial flexibility. The role that constraints play in managerial decisions makes the topic of constrained optimization a basic element of managerial economics. Later chapters consider important economic implications of self-imposed and social constraints. This analysis is important because value maximization and allocative efficiency in society depend on the efficient use of scarce economic resources.

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