22-03-2012, 01:00 PM
Capacity utilization
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Capacity utilization is a concept in economics and managerial accounting which refers to the extent to which an enterprise or a nation actually uses its installed productive capacity. Thus, it refers to the relationship between actual output that 'is' produced with the installed equipment and the potential output which 'could' be produced with it, if capacity was fully used.
Economic significance
If market demand grows, capacity utilization will rise. If demand weakens, capacity utilization will slacken. Economists and bankers often watch capacity utilization indicators for signs of inflation pressures.
It is believed that when utilization rises above somewhere between 82% and 85%, price inflation will increase. Excess capacity means that insufficient demand exists to warrant expansion of output.
All else constant, the lower capacity utilization falls (relative to the trend capacity utilization rate), the better the bond market likes it. Bondholders view strong capacity utilization (above the trend rate) as a leading indicator of higher inflation. Higher inflation—or the expectation of higher inflation—decreases bond prices, producing a higher yield to compensate for the higher expected rate of inflation.
Measurement
In economic statistics, capacity utilization is normally surveyed for goods-producing industries at plant level. The results are presented as an average percentage rate by industry and economy-wide, where 100% denotes full capacity. This rate is also sometimes called the "operating rate". If the operating rate is high, this is called "overcapacity", while if the operating rate is low, a situation of "excess capacity" or "surplus capacity" exists. The observed rates are often turned into indices.
There has been some debate among economists about the validity of statistical measures of capacity utilization, because much depends on the survey questions asked and on the valuation principles used to measure output. Also, the efficiency of production may change over time, due to new technologies.
For example, Michael Perelman has argued in his 1989 book Keynes, Investment Theory and the Economic Slowdown: The Role of Replacement Investment and q-Ratios that the US Federal Reserve Board measure is just not very revealing. Prior to the early 1980s, he argues, American business carried a great deal of extra capacity. Running close to 80% indicated at the time approaching capacity restraints. Since that time, firms have scrapped much of their most inefficient capacity. As a result, a modern 77% capacity utilization now would be equivalent to a historical level of 70%.
Engineering and economic measures
One of the most used definitions of the "capacity utilization rate" is the ratio of actual output to the potential output. But potential output can be defined in at least two different ways.