Capacity Utilization Management - Research Paper Example

Question Aggregate capa utilization is defined as the ratio of real actual to real potential output for the aggregate economy (Epstein 100). In economics, capacity utilization seeks to determine the extent to which a country or an enterprise makes use of its existing productive capacity. In this case, it is a measure between actual output and potential output of the installed productive capacity (Nelson 274). Capacity utilization is seen as mainly subject to market demand. The relationship is such that when there is a rise in market demand the capacity utilization of the enterprise or the nation will rise with the demand. The reverse is also true; meaning when the market demand slackens there will be a decline in capacity utilization. In the economic scene, capacity utilization is employed to track inflation pressures (Nelson 275). In United States, data on capacity utilization is released on monthly bases by the Federal Reserve Board. This helps in tracking the extent to which the country’s productive capacity is being utilized and also forecast likely growth or decline in various sectors. Capacity utilization is measured by deducting actual production from potential production. Capacity Utilization=Real actual output-Real potential Output The data released by the Federal Reserve Bank can be plotted in a graph to show historical developments in capacity utilization. Notably, capacity utilization is represented in percentages, 100% is considered a maximum level of production. Such a graph is represented in the next part; the data represented is from 1965 through to 2012 (Federal Bureau of Reserve). Capacity Utilization in United States of America Year Question 3 One of the emergent findings is that the overall capacity utilization has declined over the years. In the 1960s capacity utilization averaged around 85 percent. Though this rate soon declined in the 1970s capacity utilization was still in a favorable level with the lowest being 76 percent. Between 1965 and 2000 the lowest level of capacity utilization was 73 percent registered in 1982. However, the lowest level of capacity utilization was witnessed in 2009 at a level of 68 percent. Even though the level has been rising steadily since then it is still lagging behind the levels witnessed in the 1960s and mid 1990s. In explaining whether these findings are to be expected it would be important to look at the general economic environment over the years. It is clear that in the 1960s, which was largely a postwar period, there was a massive growth in the economy. This massive growth was enabled by a growing demand for goods and services which prompted companies in various industries to increase their productive capacity. At the same time, companies sought to maximize on their productive capacity to meet the demand. The result was higher levels of capacity utilization. However, this scenario would falter with a general change in the economic environment. This is because the economic environment remains a major determinant of the levels of production. In times of great demand the production levels will rise and thence the capacity utilization of existent companies will also rise. Therefore, at times of slow economic growth, or recession in that case, the industries are performing below par and thence the capacity utilization is way below that of a thriving economy. Given this scenario, it is thus expected that the level of capacity utilization will falter every time there is a marked decline in economic growth. Looking at the plotted levels and matching this with the overall health of the economy, we are able to see a higher level in the 1960s. It is during this period that the United States experienced the longest period of uninterrupted period of economic expansion. At the time, the efficiency and production levels of the U.S improved markedly. However, these levels have since declined and the country hardly goes for two decades without a recession. This reality largely suggests that the findings would be expected. Question 4 The two factors likely to explain long term trends in capacity utilization are economic trends as represented by demand levels and the ability of firms to adapt to new production technologies. It is clear that capacity utilization is subject to many other factors but this study chooses to look at these two. Demand levels represent a demand side constraint. In general, every economy is driven by the level of demand. Increased demand means that firms within an economy are prompted to increase their productive capacity to meet the existent demand. With the increased demand comes other factors such as a rise in employment rates and thus increased spending. This creates a chain that helps sustain a higher demand for goods and services (Frumkin 164). Through increased demand firms or enterprises are able to operate at full or near full capacity a factor that has a significant effect on the level of capacity utilization. Thus, the long term trend in capacity utilization is largely hedged on the capacity of the economy to ensure marked growth in the demand levels. The other factor is the ability or capacity of firms to adapt new technologies. Unlike the demand argument, this is a supply side constraint. The inability of firms to adapt to new technologies may represent a slow growth or a stagnation of a nation’s capacity utilization. In this case, the demand maybe existent but firms are unable to satisfy this demand by using outdated or inefficient technology in their production processes (Bernstein 264). Technology is considered important in eliminating infrastructure bottlenecks and will as a result affect capacity utilization of firms both in the short-run as well as in the long term. Question 5 Following the present discussion, it is clear that the level of capacity utilization is largely driven by aggregate demand. Even though other supply side factors may come into play, the demand side factors are the major determinants. This is because an increase in aggregate demand will mean that firms are able to utilize their productive capacity optimally and thence improve their capacity utilization level. With this comes higher returns and thence an enterprise or a firm is able to reinvest this increased income to help boost supply side factors. In summary, it would help to draw focus on how to improve the demand side factors. This way, it would be possible to alter the prevalent trends which are largely a result of faltering demand during the most recent recession. Works Cited Bernstein, Michael A. Understanding American Economic Decline. Cambridge u.a: Cambridge Univ. Press, 1994. Print. Epstein, Gerald A. Macroeconomic Policy After the Conservative Era: Studies in Investment, Saving and Finance. Cambridge [u.a.: Cambridge Univ. Press, 1995. Print. Federal Bureau of Reserve. United States-Capacity Utilization. 2013. 5 November 2013 . Frumkin, Norman. Tracking America's Economy. Armonk, N.Y: M.E. Sharpe, 2004. Print. Nelson, Randy A. "On the Measurement of Capacity Utilization." The Journal of Industrial Economics Vol. 37 (3) (1989): 273-286. Read More