2. Capacity Utilisation
Capacity utilisation measures the output of a firm as a percentage of its maximum output:
For example, a school might have the capacity for 2,000 students, but have 1,700 on its roll, ie 85%
What determines capacity?
Quantity and quality of factors of production, particularly labour and capital (buildings and machinery)
Full capacity is when all buildings, machinery and staff are fully used
Actual output
Maximum output
X 100

3. Importance of capacity utilisation?
Should a firm have a high or low utilisation:
Benefits of high utilisation?
Benefits of low capacity utilisation

4. Benefits of high utilisation
High utilisation means fixed costs are spread over greater output and since fixed costs do not change as output changes, fixed costs per unit are lower with higher utilisation
This means a firm can make higher profits per unit, or lower price to gain an increase in demand
Particularly important when fixed costs are high such as?
School: capacity 2,000 students
Students
2,000
1,500
1,000
Capacity utilisation
Termly fixed costs
£3m
Fixed cost per pupil

5. Capacity utilisation examples
Car factory: monthly capacity 50,000
Output
25,000
30,000
40,000
Capacity utilisation
50%
60%
80%
Monthly fixed costs
£400m
Fixed costs per car
Variable costs per car
£10,000
Price per car
£20,000
Monthly profit/loss
Fixed costs are particularly high in capital-intensive industries like cars, which means high capacity utilisation is very important
The key benefit of high utilisation is the spreading of fixed costs over a greater output, which means lower fixed costs per unit
This means higher profits per unit sold, which means higher total profits
Alternatively, this enables a firm to lower its price and to see an increase in demand

6. Problems with over-utilisation
If a firm is already producing as much as it can (and it is possible to produce more than 100% for a while), then:
If demand increases, or it receives a large order, it will not be able to fulfil this demand. Could have made more revenues and profits
May have disgruntled customers if it cannot meet their demand
Machines need maintenance, so there is a risk of a breakdown if a machine is used continuously without shutting it down for regular maintenance
Staff need training, and if they have no spare time they will not be able to undertake training

8. Increasing capacity utilisation
If a firm is operating at well below capacity it needs to address this since costs per unit will be too high. Two ways:
Increase demand
Marketing mix
Reduce capacity
But take care that the low utilisation is not temporary – big mistake to cut capacity and then later on have to increase again

9. Assessing low capacity utilisation
Key point is to understand why
Positive reason
Recent expansion in capacity to meet future demand?
Demand fallen recently and temporarily (eg recession)?
In these cases there is no real problem
Negative reasons
Fall in competitiveness?
New competitor
Change in trend/fashion
In these cases there is an issue a firm needs to address either by acting to increase demand or by reducing capacity