Showing papers on "Capacity utilization published in 1988"

Irreversible Investment, Capacity Choice, and the Value of the Firm

Abstract: A model of capacity choice and utilization is developed consistent with value maximization when investment is irreversible and future demand is uncertain. Investment requires the full value of a marginal unit of capacity to be at least as large as its full cost. The former includes the value of the firms option not to utilize the unit, and the latter includes the opportunity cost of exercising the investment option. We show that for moderate amounts of uncertainty, the firm's optimal capacity is much smaller than it would be if investment were reversible, and a large fraction of the firm's value is due to the possibility of future growth. We also characterize the behavior of capacity and capacity utilization, and discuss implications far the measurement of marginal cost and Tobin's q.

The importance of economies of scale, capacity utilization, and density in explaining interindustry differences in productivity growth

Abstract: APPLICATION TO AIR TRANSPORT, RAILROADS, ELECTRIC POWER, TELECOMMUNICATIONS, URBAN BUS AND TRUCKING

Related or Unrelated Diversification: A Resource Based Approach.

Abstract: We investigate the idea that firms diversify to utilize excess capacity of resources. Knowledge of these resources allows us to make predictions about the direction of a firm's expansion. We expect...

Evaluating the Extended Target Zones Proposal for the G3

Abstract: This paper evaluates the extended target zone proposal of Williamson and Miller using the National Institute world economic model (GEM). Williamson and Miller's proposals envisage that real exchange rates will be controlled by movements in relative interest rates, that fiscal policy will be used to steer nominal demand towards a target which depends on capacity utilization, inflation and the current balance, and that the average level of world interest rates will be used to control global nominal demand. We evaluate the performance of these rules for the United States, Germany and Japan over the period 1975-84, using control methods to determine the best choice of parameters in the feedback rules. We then consider how history would have differed from actual events had such rules been in place. The results suggest that such rules would have led to a significant improvement in economic performance: exchange rate variability would have been reduced and the dramatic increase in United States interest rates which took place after 1980 would have been avoided.

Calculating Equity-Neutral Water and Sewer Impact Fees

Abstract: Equity-neutral impact fees should equalize the burden of paying for infrastructure facilities on all residents of a community regardless of when they move there. This article demonstrates how the method for computing impact fees determines who bears the cost burden. The article concludes the following: Impact fees, if set properly, can achieve an equity-neutral result. Equity-neutral fees are highly dependent on inflation, financing, and absorption assumptions. Economies of scale must be significant for cost savings at capacity to outweigh the carrying costs during the period in which the excess capacity is absorbed; it may be preferable to build smaller facilities with smaller excess capacity to be absorbed. An equitable approach should include regular adjustments to accommodate differences between the initial assumptions used for setting impact fees and the actual inflation and absorption rates.

Financial Capacity, Reliquification, and Production in an Economy with Long-Term Financial Arrangements

Abstract: This paper characterizes a multi-period production economy in which borrowers and lenders enter long-term financial contracts. A key feature is that aggregate production and borrowers' capacity to absorb debt -- their "financial capacity" - are jointly determined endogenous variables, in the spirit of Gurley and Shaw (1955) Expectations of future economic conditions govern financial capacity, which in turn influences current capacity utilization. Further, disturbances in the present may persist into the future by influencing borrowers' net asset positions. Finally, borrowers may substitute future for current production by preserving their assets in hard times, behavior akin to reliquification as described in Eckstein and Sinai (1986).

Capacity Utilization and Productivity Measurement: An Application to the U.S. Automobile Industry

Abstract: Capacity utilization measures have traditionally been constructed as indexes of output for a firm, industry, or economy, as compared to “potential” output The determination of “potential” or “capacity” output has, however, rarely been based on an explicit theoretical economic foundation Recently various studies, including Berndt and Morrison (1981) and Morrison (1982, 1985, 1986), have provided theoretical and empirical analysis in the tradition of Cassels (1937), Klein (1960), and Hickman (1964) on economic capacity utilization measures within an optimization framework Capacity output, Y*, is characterized by the steady-state level of production given the existing level of stocks and exogenous prices of inputs and determined as the tangency point between the short- and long-run average cost curves The capacity utilization (CU) ratio is then constructed as the ratio between this and the realized level of output Y, CU = (Y/Y*) Theoretical models based on restricted-cost functions provide the required structure within which to characterize and analyze these measures These measures allow capacity output to be characterized as an optimal, as contrasted to maximal, output level given input stocks They also allow for economic interpretation; they provide explicit inference about how changes in exogenous variables will affect Y* and the CU ratio

Recent Nonparametric Measures of Productive Efficiency

Abstract: Since Farrell (1957) introduced a nonparametric method of estimating a production frontier, there have occurred three major developments in recent years for measuring productive efficiency in a nonparametric way One is the attempt by Afriat (1972) to apply a nonparametric method for testing whether a finite body of input-output data (or, in some cases price quantity data) is consistent with an optimal production (or profit) behavior His characterizations associate a production function with a given input output data set subject to the limitation that the production functions have a certain property eg, quasi-concavity, monotonicity and that the data points are represented as efficent either exactly or as nearly as possible This line of economic consistency tests has been followed up by several authors in recent times eg, Hanoch and Rothschild (1972), Diewert and Parkan (1983) and Varian (1984) A second major attempt is by Johansen (1972) who proposed a linear programming (LP) model of deriving an industry production frontier from input output data of individual firms By explicitly introducing a statistical distribution of the input output coefficients (ie the capacity distribution) and a capacity utilization function he derived the conditions under which the aggregate production frontier will have some functional forms such as Cobb-Douglas Several authors have followed up this line of work eg, Sato (1975), Forsund and Jansen (1985)

Excess Capacity, Cyclical Production, and Merger Motives: Some Evidence from the Capital Markets

Abstract: THE theoretical foundations of merger are weak and ad hoc; however, recent advances in the theory of the firm pave the way for a construct that may help alleviate this problem. The purpose of this article is to explore the theory of cost in search of a stronger, though not necessarily general, theory of merger. Firms sometimes face demand insufficient to support production at the cost-minimizing rate. They respond by producing more slowly and periodically idling their facilities.2 This implies that intermittent excess capacity might prompt a firm to expand its product line through merger to reduce idle capacity and minimize production costs. In this article we present evidence that these cost-related issues are an empirically important motive for merger. Differentiating between so-called cost-based and monopoly mergers presents a problem of considerable magnitude for antitrust law enforcement authorities.3 Potentially a means of acquiring market power, merger

Excess capacity as a commitment to promote entry

Abstract: THIS PAPER studies dominant firms' incentives for holding capacities in excess of their production requirements. The explanation most frequently put forward is to view behaviour of this kind as an attempt to set up "barriers to entry". As emphasized by Spence [1977], holding excess capacity is a relatively effective form of entry deterrence. It has the great advantage of constituting a credible threat to potential entrants because a large fraction of capacity costs are usually irreversible. The view that holding excess capacities constitutes a form of anticompetitive behaviour has to be qualified, however. Part of the motivation for holding them may well be of a more benign nature: many large firms maintain economic relations with other smaller upstream (or downstream) companies. Quite often they make up a considerable part of these companies' total activities. The companies usually have to invest certain specific sunk costs into their relationship with the dominant firm. Before deciding on these sunk investments they will often like to have some assurance that the dominant firm will not behave opportunistically once these sunk costs have been incurred. By opportunistic behaviour we mean a strategy whereby the dominant firm reduces the quantity it demands (or supplies) at any given price to such an extent that the companies can no longer obtain an economic rate of return on their sunk investments. In the absence of long run contracts, a dominant firm's decision to invest into excess capacities may well be an effective means to give the upstream (or downstream) firms the assurance they require. The essential message is thus as follows. Rather than (or in addition to) being a threat to potential entrants, excess capacity held by a dominant firm may also constitute a promise to upstream suppliers (or downstream retailers). They constitute an effective promise to buy (or supply) a sufficiently large quantity at any given price to ensure that the upstream (or downstream) firm

Irreversible supply functions revisited

Abstract: This paper presents a successful application of an irreversible supply model to the UK egg sector. The model has been developed to overcome the problems that the conventional approaches to irreversible supply modelling face when used with a partial adjustment framework. The results indicate that the supply response to price changes under excess capacity is less than a third of that under non-excess capacity, but that the long-run response is symmetric, as required by the underlying theory. Furthermore, the long-run elasticity from a conventional, symmetric, partial-adjustment model is some 40% larger than that of the asymmetric model, implying that the importance of the asymmetric specification extends beyond an interest in the short-run adjustment path.

Excess Capacity in U.S. Agriculture: An Economic Approach to Measurement

Abstract: This report measures excess capacity in U.S. agriculture, which is defined as the difference between potential supply of farm output (actual production plus potential output from acreage reduction programs) and commercial demand (total use adjusted for noncommercial exports) at prevailing prices. The study method enables analysts to assess and estimate excess capacity since 1940. Excess agricultural capacity has been increasing since 1979. The value of excess capacity in 1986 ($12.5 billion) exceeded the previous peak in the sixties, the result of greater agricultural output and a sharp decline in agricultural exports after 1981.

The Effects of Alternative Regulatory Policies on Utility Investment Strategies

Abstract: The environment for planning and constructing power plants has undergone substantial changes since the early 1970s. After this decade of change, many utilities are completing costly plants that are larger than necessary to satisfy current demand and requesting that the plants be added to the rate base. The Used and Useful (UU) and the Prudent Investor (PI) criteria have been applied by increasing numbers of regulatory commissions to determine whether excess capacity plants should be included in the rate base. This paper considers whether these criteria will induce firms to invest efficiently. Much of the discussion of these criteria has focused on developing an appropriate method for allocating excess capacity costs between consumers and investors.' It is widely recognized that allocating some of the excess capacity costs to investors increases the risk faced by utilities.2 This increased risk both increases the market cost of capital and reduces the utility's incentive to invest efficiently in new plants in the future. Consumers therefore trade lower current expenses for higher capital and operating costs in the future. The importance of these concerns depends on the answers to two questions: (1) how soon will new capacity be needed and (2) to what extent will the current policy affect future allowed rates of return and capital investment? In response to the first question, some analysts indicate that the situation of current excess capacity will be reversed in the early 1990s.3 This paper explores the second question by developing a simple model to consider the relation between the UU or PI policies, the allowed rate of return, and the level of future investment. This important relationship is complex. Some writers have emphasized capital market con-

The trade cycle under capital shortage and labour shortage On Witteveen's synthesis of the overinvestment and underinvestment theory of the trade cycle

Abstract: One of the main insights one arrives at by reading Witteveen's treatise on economic growth and the trade cycle, Structuur en conjunctuur, l is that the characteristics of the trade cycle in a situation of capital shortage differ fundamentally from those in a situation of labour shortage. These differences can especially be traced back to the differences in the second phase of the upswing and therefore to the causes of the upper turning point. Compared with a situation of labour shortage, the upswing under capital shortage is rather prolonged. The reason is that when capital is the scarce factor of production, the ceiling of actual production is determined by productive capacity. Thus, when the economy hits the ceiling during the upswing, entrepreneurs have an incentive to expand productive capacity further, which in turn leads to excess demand in the market of produced goods and hence to a rise in goods prices. Consequently, real profits will increase and the real wage sum will decrease, thus freeing the means of production for the production of investment goods (forced savings). When, after some time, the inflationary process leads to monetary restriction, national expenditure slows down, with the result that excess capacity appears. Then, the upper turning point has been passed and the economy enters the cyclical downswing. The downswing is a natural consequence of the upswing: it is the only way to remove the excess capacity which has been built up by overinvestment during the secondary phase of the upswing. According to Witteveen the above argument corresponds globally with the pre-war overinvestment theories of the cycle of, for instance, Hayek, Machlup and Spiethoff.2 Although the overinvestment theorists also emphasize the sec­ toral imbalances, horizontal and vertical disproportionalities which develop * I am indebted to Mr A. R. M. Gigengack and Mr J. P. M. Jacobs for corrections in my use of the English language and in the mathematics, respectively.

A User's Guide to Capacity-Utilization Measures

Abstract: The U.S. Census Bureau and the Federal Reserve prepare the two most widely disseminated indexes of capacity utilization. This article, the second of a two-part series on capacity utilization, explains how the indexes are constructed and analyzes the advantages and shortcomings of both approaches.

Investment, Sales Constraints and Profitability in France, 1957-1985

Abstract: This paper is deveoted to the analysis of the investment bahavior of the firm in the context of a quantity rationing ( or disequilibrium) model with monopolistic competition on the goods market. Investment i entirely profit-driven as in the q-theory of investment. The profit variable is however decomposed into three components: the markup rate on variable costs, the capacity utilization rate and the discrepancy between the optimal and the actual-labor ratios. The model has the same mong run implication as an accelerator model if and only if the optimal capacity utilization rate is constant in the long run. The suggested quantity rationing model is estimated on French data, over the period 1956-1985. The emphasis is on the the investmentequation. the parameter estimates are shown to have remained fairly stable over time.

Financial capacity, reliquification, and production in an economy with long-tem financial arrangements

Abstract: This paper characterizes a multi-period production economy in which borrowers and lenders enter long-term financial contracts. A key feature is that aggregate production and borrowers' capacity to absorb debt -- their "financial capacity" - are jointly determined endogenous variables, in the spirit of Gurley and Shaw (1955) Expectations of future economic conditions govern financial capacity, which in turn influences current capacity utilization. Further, disturbances in the present may persist into the future by influencing borrowers' net asset positions. Finally, borrowers may substitute future for current production by preserving their assets in hard times, behavior akin to reliquification as described in Eckstein and Sinai (1986).

The trade cycle under capital shortage and labour shortage

Abstract: One of the main insights one arrives at by reading Witteveen’s treatise on economic growth and the trade cycle, Structuur en conjunctuur,1 is that the characteristics of the trade cycle in a situation of capital shortage differ fundamentally from those in a situation of labour shortage. These differences can especially be traced back to the differences in the second phase of the upswing and therefore to the causes of the upper turning point. Compared with a situation of labour shortage, the upswing under capital shortage is rather prolonged. The reason is that when capital is the scarce factor of production, the ceiling of actual production is determined by productive capacity. Thus, when the economy hits the ceiling during the upswing, entrepreneurs have an incentive to expand productive capacity further, which in turn leads to excess demand in the market of produced goods and hence to a rise in goods prices. Consequently, real profits will increase and the real wage sum will decrease, thus freeing the means of production for the production of investment goods (forced savings). When, after some time, the inflationary process leads to monetary restriction, national expenditure slows down, with the result that excess capacity appears. Then, the upper turning point has been passed and the economy enters the cyclical downswing. The downswing is a natural consequence of the upswing: it is the only way to remove the excess capacity which has been built up by overinvestment during the secondary phase of the upswing.

Impact of Arms Production on Third-World Distribution and Growth

Abstract: While common sense would seem to indicate that increased defence expenditures are likely to harm an LDC’s development efforts, economic theory does not provide any clear prediction of how the net impact of an increase in the military burden would influence growth, development or welfare.1 Classical theory, for example, would predict on the basis of resource allocation that increases in defence will decrease investment and/or civilian consumption and thus reduce growth or welfare. Increased military burdens would, in this situation, have to be justified on the basis of other social welfare gains such as an increase in collective security. Keynesian theory, on the other hand, implies that in the presence of inadequate effective demand the operation of the income multiplier would imply an increase in national product, resulting from additional defence expenditures; thus, there are purely economic rationales for increased military spending. More specifically, for economies operating with substantial excess capacity, additional demand and output from expanded military expenditure will increase capacity utilization, thereby increasing the rate of profit and possibly accelerating investment. Whether in the short and long run the former or latter effect dominates will determine the final influence exerted by defence on growth.2

Measuring the Unseen A Primer on Capacity Utilization

Abstract: Capacity-utilization measures can be useful in evaluating industry price pressures, investment, and war mobilization capabilities. In this first article of a two-part series, the authors define and examine some of these measures. The upcoming July 1 Economic Commentary uses the concepts to analyze two widely disseminated indexes of capacity utilization.

Determination of batch sizes in multi-product, multi-stage situation and assessment on capacity utilization

Abstract: This paper describes the method of determining batch sizes in a multi-product, multi-stage situation and presents a Decision Support System (DSS) for capacity utilization. A heuristic model has been developed for modifying the optimal batch sizes in a manner such that machine hour and labour productivity constraints are not violated. The capacity utilization so determined will also suggest and identify the need for reduction of number of set-ups.