Capacity Utilization Rate

You're making waffles for breakfast. You make five waffles in a half hour. Could you have made more? Probably. But it's just Sunday morning breakfast, not a pit crew for a NASCAR race.

That's kind of the thinking behind capacity utilization. How much of your capacity are you using? Just like you might have the capacity to produce more waffles than you did (we'll set your capacity utilization rate at 50%), large organizations and even whole economies can produce more. Capacity utilization rates are used by entire countries (as well as individual corporations) to ensure they are using all their resources for the right amount of production.

The figure is reported as a percentage with the formula of actual output / potential output x 100. A main goal of a manufacturing company, for example, is to be able to increase their production output without increasing their per unit costs. If they can make more products without hiring new people, leasing additional space or buying new equipment, their capacity utilization rate will go up.

So let's say We Utilize Everything Inc. is now producing 15,000 units of phone batteries a week at a cost of $0.20 per unit. Then they get a big order of 5,000 batteries from a new overseas customer, and are very pleased to find out they can use some of their excess capacity (people, equipment, raw materials) to produce 20,000 batteries and keep the current cost per unit at $0.20. We Utilize Everything's capacity utilization rate is now a healthy 75% (15,000/20,000).

The Federal Reserve Bank closely monitors capacity utilization rates for the U.S. as one barometer of how the economy is doing. If the rates are high, that's a sign of a very healthy economy with little unemployment, but low rates would be a sign of a sluggish economy.