Capacity Utilization Measures: Underlying Economic Theory and an Alternative Approach

Measures of industrial capacity utilization (hereafter, CU) have been used extensively in helping to explain changes in the rate of investment, labor productivity and inflation. The CU measures have also been used to obtain indices of capital in use, as distinct from capital stock in place. A number of alternative measures of CU are periodically calculated and published; the 1980 Economic Report of the President, for example, contains three series, that by the Federal Reserve Board, the U.S. Department of Commerce (Bureau of Economic Analysis) and the Wharton School of Finance. Other publicly available series are those prepared by McGraw-Hill Publishing Company, the U.S. Department of Commerce (Bureau of the Census), and Rinfret-Boston Associates, Inc. Although a host of CU measures is publicly available, it is not at all clear how one should interpret changes over time in each measure or variations among them. A principal reason underlying these interpretation problems is that the crucial link between underlying economic theory and the constructed measure of CU is weak. One way in which this issue has manifested itself in the policy domain over the last five years has been with respect to the uncertain effects of dramatic increases in energy prices on capacity output and on CU. Each of the CU measures noted above is computed in such a way that explicitly ignores any role for energy prices. Yet several times during the last decade, though growth to apparently high rates of CU had taken place, investment and average labor productivity were much lower than expected, and the rate of price increase much greater. In brief, during the last decade the explanatory power of alternative CU measures has dropped sharply. Some have conjectured that post-OPEC energy price increases may have brought about major changes in the U. S. economy so that old quantitative relationships between measured CU and investment, labor productivity, and price inflation may have been altered substantially. In order to assess effects of changes in PE on CU, a re-examination of the notion and measurement of CU is needed, based on the framework of the economic theory of the firm. That is the focus of this paper.