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• This resource provides an example of an activity for a topic within Theme 2.

• The Planning Activity document suggests how this resource can be incorporated in lessons.

Planning activity: Theme 2

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Are you working hard enough?

Capacity utilisation

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How many hours homework could you do each evening?

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How many hours homework could you actually do each evening?

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How many hours homework could you do each evening?

This is your full capacity.

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actual hours worked each evening x 100%

full capacity

e.g. 1 hour x 100% = working at 33% capacity

3 hours

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Miah Enterpises Ltd produces state of the art widgets using the most up-to-date capital equipment…

The machine is capable of producing 10,000 units per week. Widgets are produced to order. Sales are currently 8,000 per week.

actual output per week/month/year x 100%

full capacity

a)What is total capacity?

b)What is actual output?

c)Calculate capacity utilisation

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The machine is capable of producing 10,000 units per week. Widgets are produced to order. Sales are currently 8,000 per week. Fixed costs are currently £10,000 per week.

a)Calculate fixed costs per unit at full capacity

b)Calculate fixed costs per unit at the current level of sales

c)What will happen to fixed cost per unit if the firm gets closer to full capacity?

d)What impact will this have on profit?

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Selling price = £10/unit

Variable cost/unit = £2/unit

Gross margin = £8/unit

If fixed cost per unit = £1 then profit will be £7/unit

If fixed cost per unit = £1.20 then profit will be £6.80/unit

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Selling price = £10/unit

Variable cost/unit = £2/unit

Gross margin = £8/unit

If fixed cost per unit = £1 then profit will be £7/unit

If fixed cost per unit = £1.20 then profit will be £6.80/unit

Variable cost /unit =£2

At full capacity, fixed cost per unit is £1.

Unit cost = £3

Selling price – unit cost = £7 profit per unit.

At 80% capacity, fixed cost per unit is £1.20

Unit cost = £3.20

Selling price – unit cost = £6.80 profit per unit.

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Make up your own business example

Make up a name for your business

• Full capacity

• Actual output

• Total fixed costs

• Variable unit cost

• Selling price per unit

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Copy these details from your partner

• full capacity

• actual output

• total fixed costs

• variable unit cost

• selling price per unit

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a)What is total capacity?

b)What is actual output?

c)Calculate capacity utilisation

d)Calculate fixed costs per unit at full capacity

e)Calculate fixed costs per unit at the current level of sales

f) What will happen to fixed cost per unit if the firm gets closer to full capacity?

g)What impact will this have on profit?

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Causes could be:

• Demand side:

– e.g. product less fashionable

– e.g. product seasonal

– e.g. product income elastic in a recession

• Supply side

– e.g. new competitors

Low capacity

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Consequences could be:

• High fixed costs/unit will reduce profitability (may not be possible to increase prices)

• If visible could give a poor impression to potential customers

• Underused staff

Low capacity

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In the long term – yes

• High fixed costs/unit will make the firm uncompetitive

In the short-term – possibly not

• It means that the firm can react quickly to a new order (could be useful if the firm is expanding into a new market)

• Time for maintenance and staff training

So, it depends if it is a short-term or long-term problem

Is low capacity always a problem?

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Good because fixed costs per unit are lower

But…

Leaves no time for maintenance (could lead to breakdowns)

Not possible to take on unexpected orders (the only way to increase output would be to buy a new machine)

So… 85-90% capacity might be better

Full capacity

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Capacity utilisation

• Capacity is the v_____________ of output a firm is capable of producing. Capacity utilisation measures actual output as a percentage of the firm’s capability. If the maximum capacity is 10,000 units a month and the actual output is 6,500 units, capacity utilisation is _______%.

• As fixed (o__________________) costs are related to maximum capacity, if the firm has low capacity utilisation, its fixed costs per unit will be ______________ and so too will be its average total costs per unit.

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Capacity utilisation

• Capacity is the volume of output a firm is capable of producing. Capacity utilisation measures actual output as a percentage of the firm’s capability. If the maximum capacity is 10,000 units a month and the actual output is 6,500 units, capacity utilisation is 65%.

• As fixed (overhead) costs are related to maximum capacity, if the firm has low capacity utilisation, its fixed costs per unit will be higher and so too will be its average total costs per unit.

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Capacity utilisation

• Capital intensity raises a separate issue. To what extent are the total costs of the business weighted towards fixed capital (such as machinery)? Or is the business labour intensive, i.e. labour costs form a high proportion of total costs?

• The former case is more likely to be true of large firms (especially in the manufacturing sector) whereas the labour intensive firms are more likely to be ______________ firms especially in the _________________ sector.

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