4.4. Capacity utilisation

Question 1

Define capacity utilisation

Answer 1

• the proportion of maximum output capacity currently being achieved
• (current output level/ maximum output level) x 100 = rate of capacity utilisation

Question 2

Why is capacity utilisation an important concept?

Answer 2

• 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

Question 3

Define excess capacity

Answer 3

exists when the current levels of demand are less than the full capacity of a business - also known as spare capacity

Question 4

Define full capacity

Answer 4

when a business produces at maximum output

Question 5

Advantages of operating at full capacity (3)

Answer 5

• Its fixed costs per unit are at their lowest possible level.
• The firm is assumed to be using all of its fixed assets effectively, therefore profits should be high
• It will be perceived as a successful country both internally and externally leading to positive effects. Internally, employees will feel a sense of pride working for such a successful organisation. Externally, if customers know that a firm is working at full capacity it will assume that it is offering a good product.

Question 6

Drawbacks of operating at full capacity (4)

Answer 6

• Staff may feel under pressure due to workload
• Machinery will be working flat out and there may be sufficient time for maintenance => affects quality of the products
• Increased capacity not yet match increased demand
• If there is lower demand, there can be loss of sales

Question 7

Advantages of operating at excess capacity

Answer 7

opposite of drawbacks of operating at full capacity

Question 8

Disadvantages of operating at excess capacity

Answer 8

• Higher average fixed costs
• Opportunity costs
• Inefficiency/unproductivity
• Decreases profitability

Question 9

Excess capacity - what are the options?

Answer 9

Short term:

• maintain high output levels but add to stocks - could be expensive
• adopt a more flexible production system allowing other goods to be made that might be sold at other times of the year
• offer flexible employment contracts

Long term:

• A cut in production capacity by cutting overheads to increase efficiency - rationalisation
• research and development into new products

Question 10

Define capacity shortage

Answer 10

when the demand for a business’ products exceed the production capacity

Question 11

Full capacity - what are the options?

Answer 11

• increase scale of operation by acquiring more production resources
• outsourcing: using a thrid party to undertake part of the production process rather than doing it within the business using the firm’s own employees

Question 12

Advantages of outsourcing (5)

Answer 12

• Reduction and control of operating costs - specialist firms can be cheaper because they benefit from economies of scale
• Increased flexibility - fixed costs are converted into variable costs, contracts can be cancelled if demand falls
• Improved company focus
• Access to quality services and resources => improved quality
• Freed up internal resources

Question 13

Disadvantages of outsourcing (3)

Answer 13

• Loss of jobs within the business => decreased motivation and productivity
• Quality issues - processes cannot be monitored by managers, specialist firms have other clients => won’t prioritise the firm => might have to send out quality assurance inspectors
• Security - confidential information can leak