Measurement and Significance of Capacity

Key Concepts of Capacity

Capacity refers to the maximum level of output that a business can potentially achieve with its existing levels of resources (labour, capital and technology).
There are variety of ways to measure capacity such as physical capacity (number of products that can be produced), labour hours (number of hours worked) and financial capacity (amount of money available to invest in output).
Capacity utilisation is the proportion of potential output that is actually being achieved. High capacity utilisation would suggest that a business is being very effective in using its resources.

Full capacity means that a business is operating at its maximum potential level of output with the resources it has.
Operating at full capacity usually results in lower unit costs because fixed costs are spread over a larger number of units. This can help to improve efficiency and profitability.
Spare capacity implies that a firm is not fully utilising its resources or potential for production. This often results in higher per unit costs because the same fixed costs are spread over fewer units.

High levels of capacity utilisation can indicate a business is performing well and making effective use of its resources. However, consistently operating at very high levels may also mean the firm has little room for sudden increases in demand or emergencies.
Low levels of capacity utilisation are not necessarily a bad thing as it allows the business to handle fluctuations in demand. However, it may also indicate that resources are not being used efficiently which can affect profitability.
It’s also crucial to remember, capacity utilisation can be a key deciding factor for planning business expansion. High rates may suggest consideration for expansion while low rates might indicate a need for downsizing.
Optimum capacity utilisation is usually considered to be around 80-90%, allowing businesses to benefit from economies of scale without risking overstretching resources.
It’s important to note that capacity utilisation will vary over time due to factors such as seasonal demand, economic conditions, changes in market trends, and strategic decisions made by the business.
Capacity utilisation is a useful indicator of underlying demand for a firm’s products and can be used to inform decisions about pricing, investment, employment, and output levels.