This resource provides an example of. an activity for a topic within Theme 2.

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• This resource provides an example of

an activity for a topic within Theme 2.

• The Planning Activity document

suggests how this resource can be

incorporated in lessons.

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Are you working hard enough?

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How many hours homework could you do

each evening?

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How many hours homework could you

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How many hours homework

could you

do each evening?

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actual hours worked each evening x 100% full capacity

e.g. 1 hour x 100% = working at 33% capacity 3 hours

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Miah Enterpises Ltd produces state of the art widgets using the most up-to-date capital

equipment…

The machine is capable of producing 10,000

units per week. Widgets are produced to order. Sales are currently 8,000 per week.

actual output per week/month/year x 100% full capacity

a)What is total capacity?

b)What is actual output?

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The machine is capable of producing 10,000

units per week. Widgets are produced to order. Sales are currently 8,000 per week. Fixed costs are currently £10,000 per week.

a)Calculate fixed costs per unit at full capacity

b)Calculate fixed costs per unit at the current level of sales

c)What will happen to fixed cost per unit if the firm gets closer to full capacity?

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Selling price = £10/unit

Variable cost/unit = £2/unit Gross margin = £8/unit

If fixed cost per unit = £1 then profit will be £7/unit

If fixed cost per unit = £1.20 then profit will be £6.80/unit

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Selling price = £10/unit Variable cost/unit = £2/unit Gross margin = £8/unit

If fixed cost per unit = £1 then profit will be £7/unit If fixed cost per unit = £1.20 then profit will be £6.80/unit

Variable cost /unit =£2

At full capacity, fixed cost per unit is £1.

Unit cost = £3

Selling price – unit cost = £7 profit per unit.

At 80% capacity, fixed cost per unit is £1.20 Unit cost = £3.20

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Make up your own business

example

Make up a name for

your business

• _•

Full capacity

_{Actual output}

• Total fixed costs

• Variable unit cost

• Selling price per

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Copy these details from your partner

• full capacity

• actual output

• total fixed costs

• variable unit cost

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a)What is total capacity?

b)What is actual output?

c)Calculate capacity utilisation

d)Calculate fixed costs per unit at full capacity

e)Calculate fixed costs per unit at the current level of sales

f) What will happen to fixed cost per unit if the firm gets closer to full capacity?

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Causes could be:

• Demand side:

– e.g. product less fashionable – e.g. product seasonal

– e.g. product income elastic in a recession

• Supply side

– e.g. new competitors

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Consequences could be:

• High fixed costs/unit will reduce

profitability (may not be possible to

increase prices)

• If visible could give a poor impression

to potential customers

• Underused staff

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In the long term – yes

• High fixed costs/unit will make the firm uncompetitive

In the short-term – possibly not

• It means that the firm can react quickly to a new order (could be useful if the firm is

expanding into a new market)

• Time for maintenance and staff training

So, it depends if it is a short-term or long-term problem

Is low capacity always a

problem?

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Good because fixed costs per unit are lower

But…

Leaves no time for maintenance (could lead to breakdowns)

Not possible to take on unexpected orders (the only way to increase output would be to buy a new machine)

So… 85-90% capacity might be better

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Capacity utilisation

• Capacity is the v_____________ of output a firm is capable of producing. Capacity

utilisation measures actual output as a percentage of the firm’s capability. If the maximum capacity is 10,000 units a month and the actual output is 6,500 units, capacity utilisation is _______%.

• As fixed (o__________________) costs are related to maximum capacity, if the firm has low capacity utilisation, its fixed costs per unit will be ______________ and so too will be its average total costs per unit.

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Capacity utilisation

• Capacity is the volume of output a firm is capable of producing. Capacity utilisation

measures actual output as a percentage of the firm’s capability. If the maximum capacity is 10,000 units a month and the actual output is 6,500 units, capacity utilisation is 65%.

• As fixed (overhead) costs are related to maximum capacity, if the firm has low

capacity utilisation, its fixed costs per unit will be higher and so too will be its average total costs per unit.

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Capacity utilisation

• Capital intensity raises a separate issue. To

what extent are the total costs of the business weighted towards fixed capital (such as

machinery)? Or is the business labour intensive, i.e. labour costs form a high proportion of total costs?

• The former case is more likely to be true of large firms (especially in the manufacturing sector) whereas the labour intensive firms are more likely to be ______________ firms

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Capacity utilisation

• Capital intensity raises a separate issue. To

what extent are the total costs of the business weighted towards fixed capital (such as

machinery)? Or is the business labour intensive, i.e. labour costs form a high proportion of total costs?

• The former case is more likely to be true of large firms (especially in the manufacturing sector) whereas the labour intensive firms are more likely to be smaller firms especially in the services/tertiary sector.

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True or false?

• Low capacity utilisation means low unit costs.

• Low capital intensity means high labour costs per unit.

• High labour intensity may mean high costs but high flexibility and good customer service.

• High capacity utilisation keeps unit costs down as machinery and staff are being used

productively.

• An increase in capital intensity might lead to redundancies.

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Six months ago, John Collins started up a retail business with overheads of £4,000 per week, including £900 on staff, £700 on rent and the rest on the cost of leasing a state-of-the-art automated supply system. This enables customers to order over the phone, the internet or in person, and a robotic stock-picking system finds the item and delivers it to a collection bay. Current unit sales of 7,200 per week are close to the system’s maximum capacity of 8,000 units.

a)Calculate the firm’s % capacity utilisation

b)Calculate the capital intensity of John Collins’ business.

c)A rival retailer has a labour intensity of 70%. Identify one advantage and one disadvantage to John Collins of its capital intensity.

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Calculate the firm’s % capacity utilisation

72/80 = 90%

Calculate the capital intensity of John Collins’ business.

24/40 = 60%

A rival retailer has a labour intensity of 70%. Identify one advantage and one disadvantage to John Collins of its capital intensity.

Advantage: speed, low wage costs

Disadvantage: less face-to-face customer interaction, customer service poorer

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JT Co’s fixed overheads of £600,000 a month pay for a maximum capacity of 200,000 units. Variable costs are £2 per unit, the selling price is £8 and current demand is for 120,000 units.

a)What is JT Co’s capacity utilisation?

b)Calculate JT Co’s fixed costs per unit at 120,000 units and at maximum capacity

c)Explain how the above data enable you to know that JT Co’s profit margin is £1 per unit at sales of 120,000 units, but £3 per unit at maximum capacity.

d)Calculate the % increase in the firm’s total profit that would result from a sales increase from 120,000 to

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What is JT Co’s capacity utilisation?

12/20 = 60%

Calculate JT Co’s fixed costs per unit at 120,000 units and at maximum capacity

60/12 = £5; 60/20 = £3

Explain how the above data enable you to know that JT Co’s profit margin is £1 per unit at sales of 120,000 units, but £3 per unit at maximum capacity.

8-2 = 6; £6-£5 = £1; £6-£3 = £3

Calculate the % increase in the firm’s total profit that would result from a sales increase from 120,000 to 200,000 units.