Capacity utilisation

Capacity utilisation is a macroeconomic term that is now commonly used in AS macro exam questions. It measures how much of the productive potential of the economy is being used at a given point in an economic cycle. Capacity utilisation falls during a recession because of falling aggregate demand for goods and services. The result is that scarce resources of land, labour and capital are not being used to their full extent.

When capacity utilisation is falling:

*The economy is likely to operate with a negative output gap (actual GDP

< potential GDP)
*The

unit costs of production may rise since fixed/overhead costs are being spread over a lower level of output
*Businesses may decide to reduce the hours worked by their employees, factories may move to short-time working or holidays may be extended ( a good example of this was the decision by many UK car manufacturers to cut production during the first half of 2009)
*Low capacity utilisation implies that the demand for new capital investment will be weaker
*When spare capacity is rising, demand-pull inflationary forces will be declining

Business surveys are commonly used to measure the extent of spare capacity in the economy. The estimated output gap is an aggregate measure of the difference between actual and potential GDP.