Capacity utilization is the amount of manufacturing capacity a company uses, expressed as a percentage of potential production. It can be an economic indicator and excess capacity is the difference between what a company can produce and what it actually produces.
Capacity utilization is the amount of manufacturing capacity that a company is using at any given time. If a company has the capacity to run three manufacturing shifts per day and only operates two shifts per day, it has a capacity utilization rate of 66.66 percent. This rate can also be calculated in number of units, so a company that can produce 10,000 parts per day, but only produces 8,000, has a capacity utilization rate of 80 percent.
Production capacity takes into account fixed costs such as factories and equipment. It does not include variable costs such as labor and materials. Once a company reaches full capacity, it will have to increase its fixed costs by buying more equipment or building new factories to produce more goods.
Capacity utilization is expressed mathematically as actual production divided by potential production. This rate is expressed as a percentage. Businesses rarely operate at 100 percent of installed productive capacity, as there will often be downtime due to equipment malfunction and other causes. A constant rate of around 85 percent is considered optimal in most industries.
When the capacity utilization rate is low, it means that companies can increase production without incurring additional fixed costs. If demand for the company’s products increases, they can produce more goods at the same cost per unit. If the rate is high, companies cannot increase production without incurring additional fixed costs to buy new machinery or build new facilities.
Capacity utilization can be an economic indicator, as economists will consider the overall industry or country capacity utilization rate when determining whether there is a risk of inflation. Inflationary pressures occur when businesses are at or near full capacity, and there is additional demand for goods. As demand for the product increases and production remains the same, prices will rise, causing inflation.
The amount of capacity a company has beyond what it is using is excess capacity. Excess capacity can be thought of as the difference between the amount of goods a company is capable of producing with its current infrastructure and the amount it is actually producing. It can also be thought of as the incremental amount of product that a company can produce at current cost. If the company wants to produce more units beyond its full capacity, it will have to incur additional costs.
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