Discuss the various aspects of capacity concepts with example in operational management?

Answer 1

The concept of capacity can be quite difficult to define and even more cumbersome to understand. There are numerous definitions of capacity, and several bases upon which to define it. The most widely used concept of capacity is the maximum potential production of an output or group of outputs by a producing unit, firm, or industry, given technology, capital stock and other factors of production. By definition, capacity is a short-run concept, since at least one input (usually the capital stock) and technology are held fixed at some level. There are at least three bases upon which to consider the concept of capacity.

First, there is an engineering concept of capacity. This concept of capacity defines a theoretical maximum rather than a real world, practical maxima (e.g. the name plate rating on an electric power generator or the maximum power rating on an engine) (Coelli, Grifell-Tatje, and Perelman, 2001). The engineering concept, however, is not a particularly useful concept for managers of fisheries and is not further considered in this Technical Report.

Another notion of capacity is the “pure physical” or “technological” notion of capacity. The physical or technological concept of capacity is the maximum potential output a producing unit, firm, or industry could produce, given technology, capital stock and other factors of production, but without any limits on the factors of production that can be changed (e.g. labour and energy) in the short run.

A third concept is the economic concept of capacity. As broadly interpreted, the economic concept of capacity is the output level that would be produced in order to satisfy some underlying economic behavioural objective, such as profit maximization or cost minimization (Morrison, 1985; Coelli, Grifell-Tatje and Perelman, 2001). This notion defines capacity as an economically-derived optimum level of output.

Regardless of whether or not capacity is defined according to an engineering maximum, a technological or purely physical maximum, or an economic optimum, capacity refers to a potential output level (e.g. the maximum potential number of automobiles a car manufacturer could produce, or the number of automobiles that must be produced in order to maximize profits). Even though all of the concepts of capacity refer to potential output, the various interpretations can be confusing to understand.

To help explain these concepts of capacity, we introduce the concept of a production function and some basic notation. Let Y be a single output; X, a variable factor of production; and Z, a fixed factor of production. A variable factor of production is an input whose level may be varied or easily changed in the short run (e.g. fuel and labour). A fixed factor is an input that cannot easily be changed in the short run (e.g. capital such as equipment and machinery). The production technology or production frontier, g, defines the maximum output attainable from a given set of economic inputs. The technology may be specified in mathematical form as Y = g(X,Z).[4]

The production function or technology may exhibit various relationships between inputs and output. Of particular concern is how the level of output changes in response to changes in the levels of variable inputs. In general, it might be expected that output would initially rise at an increasing level given increases in the variable input (Figure 1). The rate of increase in output, however, would likely reach a maximum (point A), because output would start to be limited by the fixed factor and increases in variable input use would only modestly increase total output. At some level of production, output would be as high as possible and increasing inputs would actually decrease the level of output.[5]

Figure 1 - The classic production function

The technological concept of capacity, as proposed by Johansen (1968), can be understood by viewing Figure 1. Johansen defined capacity as the maximum possible output that could be produced given technology, fixed factors and no limitations on the availability of variable production factors. The maximum output occurs at Point A in Figure 1. At the maximum or capacity level of output, inputs are fully utilized (i.e. they are used at levels yielding maximum output).

Also of particular concern is whether or not the technology exhibits increasing, decreasing, constant, or variable returns to scale. Returns to

(YK = Klein; YBM = Berndt and Morrison; YCGP = Coelli, Grifell-Tatje and Perelman; and YJ = Johansen)