key term - Production Capacity

Definition

Production capacity refers to the maximum level of output or production that a business or industry can achieve with its available resources, such as labor, equipment, and facilities. It is a crucial concept in understanding the dynamics of price elasticity of demand and price elasticity of supply.

5 Must Know Facts For Your Next Test

1. Production capacity determines the maximum quantity a firm can supply, which is a key factor in the price elasticity of supply.
2. Firms with higher production capacity are generally more price elastic in their supply, as they can more easily increase output in response to price changes.
3. Capacity utilization, or the percentage of a firm's production capacity that is currently being used, is an important consideration in understanding price elasticity of supply.
4. Firms operating at or near full capacity are less price elastic in their supply, as they have limited ability to increase output in response to price changes.
5. Economies of scale can impact production capacity, as larger firms may be able to achieve greater output with the same resources, affecting their price elasticity of supply.

Review Questions

• Explain how a firm's production capacity influences its price elasticity of supply.
  • A firm's production capacity is a key determinant of its price elasticity of supply. Firms with higher production capacity, or the ability to produce more output, are generally more price elastic in their supply. This is because they have the resources and flexibility to increase output in response to a price increase. Conversely, firms operating at or near full capacity have limited ability to increase output, making them less price elastic in their supply.
• Describe the relationship between capacity utilization and price elasticity of supply.
  • Capacity utilization, the percentage of a firm's production capacity that is currently being used, is an important factor in understanding price elasticity of supply. Firms operating at high levels of capacity utilization, close to their maximum production capacity, are less price elastic in their supply. This is because they have limited ability to increase output in response to a price change. On the other hand, firms with lower capacity utilization can more easily increase production, making them more price elastic in their supply.
• Analyze how economies of scale can impact a firm's production capacity and its price elasticity of supply.
  • Economies of scale, the cost advantages that firms obtain due to expansion, can influence a firm's production capacity and its price elasticity of supply. Larger firms that can achieve greater output with the same resources may have higher production capacity, which can make them more price elastic in their supply. This is because they have the ability to increase output more easily in response to a price change. Conversely, smaller firms may face diseconomies of scale, limiting their production capacity and making them less price elastic in their supply.

Related terms

Capacity Utilization: The degree to which a company's production capacity is being used, typically measured as the ratio of actual output to potential output.

Economies of Scale:

The cost advantages that businesses obtain due to expansion, as they are able to produce more units at a lower average cost.

Marginal Cost:

The additional cost incurred by a firm to produce one more unit of output.