Capacity Utilisation (Edexcel A Level Business): Revision Note

Calculating capacity utilisation

• Capacity utilisation is a measure of the level to which a business's assets are being used to produce output

• It compares the current output to the maximum possible output a business can produce using all of its assets and is expressed as a percentage

• Capacity utilisation is calculated using the formula

Implications of underutilisation and overutilisation of capacity

Underutilisation of capacity

• If a business has a low level of capacity utilisation, it will not be making the most of its resources and is likely to have increased unit costs

  • The fixed costs are spread over fewer units of output, resulting in higher average total costs

  • Workers may be underdeployed, leading to fears of redundancy

• Operating under capacity does provide a business with flexibility

  • There may be an opportunity to engage workers in maintenance tasks

  • The business can respond to sudden increases in demand

Overutilisation of capacity

• If a business has a high level of capacity utilisation, it may not have the flexibility to respond to new orders from customers

  • Staff will be under a lot of pressure to produce high levels of output

  • Overworked staff may be inclined to leave, increasing staff turnover 

  • Machinery may be pushed to its limits and prone to breakdowns, which disrupts production and increases costs

• High capacity utilisation will minimise average total costs and increase business competitiveness

  • If workers are busy, they are likely to feel secure in their employment 

  • A business that is busy is likely to be well thought of by customers and will attract customers who are willing to wait for products to be delivered

Ways of improving capacity utilisation

• Achieving an optimum level of capacity utilisation is a key production objective

• A business has several options available to improve its capacity utilisation

A range of ways to improve capacity utilisation

• Increasing the level of capacity utilisation results in lower unit costs

• In some cases, increasing demand and thus output is the most suitable way to increase capacity utilisation

  • For example, reducing selling prices or offering short-term price promotions can increase demand

  • If competitors go out of business, demand should pick up, which will improve capacity utilisation without the need for further promotion

• Reducing the level of overall capacity will improve the level of capacity utilisation

  • Capacity can be reduced by selling capital equipment or reducing the number of staff