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Concepts of Capacity

In the context of production and costs, we often talk about ‘capacity’ which may limit either scale expansion or scope exploration or both.

‘Full capacity’ utilisation is very often the aim of production management. If plants and equipments are not fully utilized, it is both a physical and monetary loss. When the machine remains idle, obsolescence is a likely cost just like depreciation is a cost when the machine is over utilized. Thus both over utilisation and under utilisation of capacity should be avoided, if economies have to be fully exploited.

Sometimes, ‘idle capacity’ does emerge because of a lot of factors such as breakdown of complementary machines, labor strike, non-availability of raw materials, lack of well- coordinated production plan, etc. the emergence of such idle capacity is sometimes unavoidable, despite the best intention of the management.

Every piece of machinery or plant and equipment has a licensed capacity based on engineering specifications, calculations and technical feasibility. Sometime it is also reported as ‘rated capacity’. It is safe not to operate at full capacity and to keep sometime in the reserve (almost like petrol in the reserve!). Many firm operation in imperfect market often create artificial scarcity in the referred to as ‘excess capacity’. For example, a monopolistically competitive firm always operates with excess capacity in the long run.

The existence of ‘excess capacity’ means that as output is increased, the average costs can decrease. By contrast, if the average costs remain the same (in the long run) despite increasing the level of output, it is called ‘reserved capacity’.