Incite -- (v) 1: give an incentive; 2: provoke or stir up; "incite a riot"; 3: urge on; cause to act
Sunday, June 27, 2004

More on the Super Sexy Topic of Capacity Utilization
Written by: Speculator

David Foster, over at Photon Courier, posted a very good point to my last posting on Capacity Utilization.

Bear in mind, though, that "capacity" is not really a hard number. I may have several machines that can perform a given job...when cap utilization is relatively low, I will use those that are most labor and/or energy efficient...but as utilization grows and these machines become fully busy, I start using the older & less-efficient ones--thereby creating higher labor/energy costs and consequent inflationary pressures.
David, this is a great point, and I only wish that I had seen it earlier. First, you are dead on with your comment. The cost to employ the incremental unit of capacity begins to advance as we get closer and closer to the magical number of 83 or 84%. At 77.8%, many hold that there remains first-rate capacity to dispatch. Where we begin to witness accentuated concavity is anyone's guess, I have heard discussions that suggest 79 or even 80%. (To be honest, this is one of the areas where I begin to lose appreciation for macroeconomics - each individual actor within the vast domestic economic space is unique and pontificating where the aggregate "averages" an increase in the increase of costs is akin to incantation.)

But, your comment invites some thoughts that combine the idea of Cap Util and a monetary policy that has become as accommodative as a two-dollar whore. As I have eluded to in the past, a historically low fed funds rate affects all rates, near and far, as the steepness in the yield curve fails to fully, or even at times partially, absorb the depression of near term structure.

This creates a lower cost of debt financing for all players, even those that fight for existence on the investment-grade frontier. But, for now, lets take a look at those who enjoy a solid credit rating, say mid-range investment grades.

This is where your point (of the introduction of less efficient machinery as available capacity shrinks) comes in. If my trabajo in a given organization is to allocate surplus funds (by surplus I mean cash available to the firm after all obligations, including dividends, have been met) I am more than likely going to engage in some NPV analysis. Now, as my firm's WACC falls (due to the reduction of the fed funds rate (FFR) which leads to a reduction in the risk-free rate (RFR) which leads to a reduction in the cost of my debt financing - credit spreads sympathize, especially within investment grades, with shifts in the yield curve, i.e., spreads don't blow out as the yield curve falls) the propensity for positive NPV projects to surface increases.

There is some speculation (I am not saying that I subscribe to this line of thought) that firms have recently been purchasing capital goods in an almost speculative fashion for a few reasons. First, they "know" that rates are "soon" to rise and second, they are facing the age-old conundrum of deploying otherwise dormant funds (everyone, including Microsoft, is scolded for excess cash reserves). The recent theory goes, a firm can do one of two things with this excess capital, a) hire or, b) purchase capital goods. Some speculate that firms have found justification, via reduced WACCs, to replace worn and inefficient equipment, as they believe that they can enjoy greater return on marginal capital introductions rather than marginal labor introductions (I have great employees already, and they are getting better and better at using this productivity-enhancing machinery, lets just get the capital equipment I have at the periphery replaced with some new razzle-dazzle stuff - and no fear, the NPV on this idea is positive, as my hurdle rates have never been lower, but I hear that time is running out!)

So, some speculate that we as an economy are actually adding net capacity to the system, and may even experience a decline in Cap Util rates over the short term. At the very least, we may be replacing worn and inefficient capacity, so if we begin to approach 80, 81%, we may find that firms are incurring no real increases in marginal costs.

This of course says nothing of the peril that may be waiting for firms in industries where overcapacity (telecom, airlines, autos) creates a situation where firms have no ability to pass on increased costs, as market share must be protected to maintain cash flows.

Contact The Author:

John Beck

Feedback Welcomed

Greatest Hits

The Complete United Nations Posts
Immoderate Moderates
Marketing Myopia
In defense of the Republic
UKIP in America
Playing Connect the Dots
A Point So Often Missed: The Presence of an Administered Rate
Reagan Remembrance
Dr. Wolfowitz, or How I Supported the Right War Waged in the Wrong Way for the Wrong Reasons
Divine Right of Kings and UN Mandates
A Fantastic Idea, If I Do Say So Myself
Why We Were Right to Liberate Iraq
The Crisis of Conservatism

Blogs Worth Bookmarking

Steal The Blinds
Poor Dudley's Almanac
Protein Wisdom
Anti-Idiotarian Rottweiler
New Sisyphus
Jim Treacher
Ace of Spades
Captain's Quarters
Rambling's Journal
Neolibertarian Blog
LLP Group Blog
The Llama Butchers
The Castle Argghhh
The Politburo Diktat
The Dissident Frogman
In Search of Utopia
Aaron's cc:
You Know You Wanna
Classical Values
Clowning Glory
Vice Squad
Hit & Run
Link Mecca
The Corner
Power Line
Michelle Malkin
Mises Institute
marchand chronicles
Enlighten - New Jersey

More Top Reads

SlagleRock's Slaughterhouse
This Blog is Full of Crap
Who Tends the Fires
The Bleat
Outside the Beltway
Small Dead Animals
Kim du Toit
Tman in Tennessee
Hog On Ice
Pardon My English
Mr. Minority
Speed Of Thought
La Shawn Barber
Right Wing News
USS Clueless
Belmont Club
Shades of Gray
Seldom Sober
Roger L. Simon
Tacoma Blaze
A Small Victory
Murdoc Online
Iraq Elections Diatribe
Winds of Change
Enlighten - New Jersey
Random Fate
Riding Sun
The Daily File
Matt "The Man" Margolis
Bastard Sword
Roller Coaster of Hate

News Links

Blogger News Network
National Review Online
Tech Central Station
The Drudge Report
Reason Online
Mises Institute
The Weekly Standard
Front Page Magazine
Town Hall

Affiliations, Accolades, & Acknowledgements

The Neolibertarian Network


Image Hosted by
"More tallent than a million monkeys with typewriters."
--Glenn Reynolds

Image Hosted by

Image Hosted by

Image Hosted by

Life, Liberty, Property Community

Reciprocal Blogrolling

Accidental Verbosity
Conservative Eyes
The Moderate Voice
Perpetual Three-Dot Column
Sudan Watch
Mystery Achievement
Le Sabot Post-Moderne
Comment Me No Comments
New Spew

Links That Amuse the Writers

Huffington's Toast
The IFOC News
Dave Barry's Blog
Drum Machine
Something Awful
Cox & Forkum
Exploding Dog


March 2004
April 2004
May 2004
June 2004
July 2004
August 2004
September 2004
October 2004
November 2004
December 2004
January 2005
February 2005
March 2005
April 2005
May 2005
June 2005
July 2005
August 2005
September 2005
October 2005
November 2005
December 2005
January 2006
February 2006
March 2006
April 2006
May 2006
June 2006
August 2006
March 2007
May 2007
June 2007
August 2007
September 2007
October 2007
January 2008
February 2008
March 2008
April 2008
May 2008
September 2008
November 2008
December 2008
March 2009
April 2009
June 2009
July 2009
August 2009
September 2009
October 2009
November 2009

The Elephant Graveyard

We Are Full of Shit
The Sicilian
The Diplomad
Insults Unpunished
Fear & Loathing in Iraq
Right Wingin-It
Serenity's Journal
Son of Nixon
Rachel Lucas


Site Design by Maystar
Ask not for whom the blog tolls...
This page is powered by Blogger. Isn't yours?
Weblog Commenting and Trackback by

Listed on Blogwise
Blogarama - The Blog Directory


Image Hosted by

Email Questions and Comments

Creative Commons License
This work is licensed under a Creative Commons License.
eXTReMe Tracker