A Numerical Example Illustrating Cost of Idle Capacity in Manufacturing: Advanced Study

I illustrate cost of idle capacity in manufacturing with a simple numerical model of manufacturers and buyers of cement over a business cycle with off-peak and peak demand periods. Given demand fluctuations, such as the business cycle, significant cost of idle capacity is ordinary, necessary, and desirable. My model has two types of plants manufacturing cement, plantK and plantL, each having linear total costs with absolute capacity limits. PlantK operates with low VC and high FC. PlantK, because of its low VC, produces continuously at capacity in off-peak and in peak periods. PlantL, because of its high VC, shut-downs in off-peak periods and produces at capacity in peak periods. I show results under perfect competition SRMC pricing and LR equilibrium requirement for all plants E(π) = 0. Only plantL incurs idle capacity costs. This shows a positive aspect of plantsK that they have no idle capacity costs. PlantsK are modern and make extensive use of outsourcing. Outsourcing is rising in recent years with advances in internet, computers, and telephone. Manufacturers today can depend on getting needed parts “just-in-time” from outside suppliers without maintaining inventories of parts or capacity to produce parts.

Author(s) Details

Gerald Aranoff
Professor of Accounting, Bnei Brak, Israel.

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