Definition: The capacity utilization rate is the percentage of potential economic output that is achieved compared to the actual output beyond which the average cost of production increases.
What Does Capacity Utilization Rate Mean?
What is the definition of capacity utilization rate? The capacity utilization indicates the overall growth and demand in an economy, and it is often a key indicator for the CPI. If the aggregate demand increases, the capacity utilization increases as well and vice versa. However, a CU rate of 82% or higher creates an expectation of a higher inflation rate as the aggregate demand outweighs the aggregate supply, causing demand-pull inflation.
In general, a high CU rate suggests that an economy is bullish and can generate growth. A low capacity utilization suggests that an economy is bearish and less growth-oriented, thus leaving room for the bond market to rise. The capacity utilization formula is calculated using the actual output and the maximum potential output.
Let’s look at an example.
Example
Autocars S.A. is a manufacturer of car components in North Carolina. The company manufactures approximately 50,000 components per month, but the last two months the production is lower as the company is performing some changes in its installation site. This month, the company manufactured 39,000 components.
The capacity utilization rate for Autocars S.A. is the percentage of the actual output of 39,000 over the maximum potential output of 50,000 components. Therefore:
CUR = (39,000 / 50,000) x 100 = 78%.
The high utilization rate of Autocars S.A. suggests that the company’s production costs decrease as the output increases. A the manufacturer can meet the demand of its customers, it becomes increasingly competitive. A high capacity utilization rate between 95% and 100% indicates efficient operations management. On the other hand, seasonal factors or a general decline in the aggregate demand have a negative impact on the CUR.
Summary Definition
Define Capacity Utilization Rate: The CU rate is a metric used to evaluate how much of a company’s output is being used and if it can meet the demand of a growing market.
