What is the 'Capacity Utilization Rate'

The capacity utilization rate measures the proportion of potential economic output that is actually realized. Displayed as a percentage, capacity utilization levels give insight into the overall slack that is in the economy or a firm at a given point in time. The formula for finding the capacity utilization rate is:

(Actual Output / Potential Output ) x 100

BREAKING DOWN 'Capacity Utilization Rate'

The capacity utilization rate is an important operational metric for businesses, and it's also a key economic indicator when applied to aggregate productive capacity. A company with less than 100% utilization can theoretically increase production without incurring expensive overhead costs associated with purchasing new equipment or property. Economies with ratios of under 100% can absorb significant increases in production without pushing past previous highs. The concept of capacity utilization is best applied to the production of physical goods, which are simpler to quantify.

Corporate Capacity Utilization Rates

The capacity utilization rate is important for assessing a company's current operating efficiency, and it helps provide insight into cost structure in the short term or long term. It can be used to determine the level at which unit costs rise. For instance, imagine that Company XYZ currently produces 10,000 widgets at a cost of $0.50 per unit. If it is determined that it can produce up to 15,000 widgets without costs rising above $0.50 per unit, the company is said to be running at a capacity utilization rate of 66% (10,000/15,000).

Historical Capacity Utilization Rates

The Federal Reserve gathers and publishes data on capacity utilization in the U.S. economy. Capacity utilization tends to fluctuate with business cycles, with firms adjusting production volumes in response to changing demand. Demand declines sharply during recessions, as unemployment rises, wages fall, consumer confidence wanes and business investments dip.

The Fed has published capacity utilization figures since the 1960s, spanning a number of economic cycles. All-time-high levels approaching 90% were achieved in the late 1960s and early 1970s. The deepest declines occurred in 1982 and 2009, when capacity utilization fell to 70.9% and 66.7%, respectively.

Effects of Low Capacity Utilization

Low capacity utilization is a concern for fiscal and monetary policymakers who use either policy to engage in stimulation. In 2015 and 2016, several European economies, such as France and Spain, were struggling with the effects of low capacity utilization. Despite the onset of monetary stimulus leading to historically low interest rates, inflation remained below target levels for extended periods, and the threat of deflation loomed. Low capacity utilization and high unemployment created so much slack in those economies that prices were slow to react to stimulative efforts. With so much excess capacity, rising product activity did not require significant capital investment.

RELATED TERMS
  1. Capacity Requirements Planning ...

    Capacity requirements planning (CRP) is an accounting method ...
  2. Activity Capacity

    Activity capacity refers to an activity's upper threshold of ...
  3. Utilities Sector

    The utilities sector encompasses stocks from electric, gas, water ...
  4. Utility

    Utility is an economic term referring to the total satisfaction ...
  5. Capacity

    The maximum level of output of goods and/or services that a given ...
  6. Dow Jones Utility Average - DJUA

    The Dow Jones Utility Average (DJUA) is a price-weighted average ...
Related Articles
  1. Investing

    5 Popular Utilities ETFs in 2016 (XLU, NEE)

    Discover how the five most popular utilities ETFs for 2016 can add growth and income to your portfolio. Four of these utilities ETFs outperformed the S&P 500.
  2. Investing

    ETF Flows: Utilities ETFs Stand Tall in 2016

    Find out which utilities exchange-traded funds (ETFs) have benefited the most from the huge surge in fund inflows in the early part of 2016.
  3. Trading

    Invest in Utilities With These ETFs (XLU, JXI)

    The strong uptrends shown on the charts of these utility ETFs suggest now could be the time to buy.
  4. Trading

    Why Utility Stocks Are Looking So Attractive

    Investors are in a risk-off mode and are looking to put their capital to work in safer stocks like utilities.
  5. Trading

    The Charts Suggest Utilities Are Poised to Move Lower

    Many investors are turning to utilities in light of recent volatility.
  6. Investing

    What You Should Know About Risk Tolerance and Risk Capacity

    When deciding how to invest, you need to consider your risk tolerance and your risk capacity.
  7. Investing

    The 4 Largest Utilities ETFs (XLU, VPU)

    Learn about the utilities sector, and discover the top four exchange-traded funds that can be used to gain investment exposure including XLU and VPU.
  8. Investing

    Why Utilities are the Hottest Sector (XLU)

    The performance of utilities has made it the hottest sector this year.
RELATED FAQS
  1. What is the utility function and how is it calculated?

    Economists measure utility in revealed preferences by observing consumer choices and ordering consumption baskets from least ... Read Answer >>
  2. What are the Four Types of Economic Utility?

    Understand the four main types of economic utility that apply to transactions between consumers and businesses: form, time, ... Read Answer >>
  3. How strongly does government regulation impact the utilities sector?

    Read about the impact of government regulation on the utilities sector, particularly as is pertains to the water and electricity ... Read Answer >>
  4. How can you find the demand function from the utility function?

    Learn how the utility function can be used to derive the demand function, and how both of these concepts relate to utility ... Read Answer >>
Trading Center