Capacity utilisation expresses output as a % of total potential output. For example, if a car factory could produce 1,000 cars a week and output was 740, then capacity utilisation would be 74%
Capacity utilisation is important for determining the elasticity of supply. If firms are near 100% of capacity utilisation then supply will be very inelastic, at least in the short term.
In the long term firms can increase productive capacity and increase the amount of capital.
Capacity utilisation formula. In practise firms will not want to produce at 100% utilisation as this allows no scope for fluctuations. They will prefer to target a certain % say 85% of capacity utilisation. If the % varies significantly from this amount then firms will either try to expand capacity or deal with oversupply.
Capacity utilisation is an important concept:
- It is often used as a measure of productive efficiency
- Average production costs tend to fall as output rises – so higher utilisation can reduce unit costs, making a business more competitive
- So firms usually aim to produce as close to full capacity (100% utilisation) as possible
Is there an ideal level of capacity utilisation? The answer is – it depends!
There are several reasons why businesses operate at less than 100% capacity utilisation:
Lower demand:
- General reduction in overall market demand
- Loss of market share
- Seasonal variation in demand
Increase in capacity not yet matched by increased demand:
- Possibly new technology introduced
- Provide some "slack"
Inefficiency (a problem = less competitive unit costs)
- Poor maintenance, quality, employee disruption
When a business is operating at less than 100% capacity, it is said to have "spare capacity".
Sometimes spare capacity is not the problem – a business finds itself with excess demand (i.e. it cannot produce enough to meet demand). In such circumstances, what can it do to operate at higher than 100% normal capacity? It can often:
- Increase workforce hours (e.g. extra shifts; encourage overtime; employ temporary staff)
- Sub-contract some production activities (e.g. assembly of components)
- Reduce time spent maintaining production equipment
However, there are some potential pitfalls with operating at very high capacity (i.e. around 100%):
Negative effect on quality (possibly)
- Production is rushed
- Less time for quality control
Employees suffer
- Added workloads & stress
- De-motivating if sust Fix ained for too long
Loss of sales
- Less able to meet sudden or unexpected increases in demand
- Production equipment may require repair
But there are also advantages:
Advantages of working at Full Capacity
- Lower average costs (the fixed costs are spread over more output).
- Improves image amongst customers (business looks successful, busy customers).
- Increases Staff Motivation and Job Security.
