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    This question has baffled me for some time now, and I'm aware it's quite simple - but is spare capacity good or bad for an economy/nation/firm?

    Spare capacity could mean a business is able to match a change in quantity demanded, but also means that they aren't as productively efficient as they could be.

    In fact there are many effects of spare capacity, I am ultimately wondering if the benefits of having spare capacity outweigh the costs.

    Furthermore, does "operating with spare capacity" mean using the remaining spare capacity or operating at a level that leaves some spare capacity?

    Cheers.
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    I personally think having some spare capacity is good but not so much. If a business were working at full capacity, this might mean higher wages because workers can then demand them. Since wages goes into the cost of production, this would cause higher prices and as a result, inflation.
    Also if there is spare capacity, the business would be less vulnerable to disruption. If one of the machines stops operating, it's not like you can increase the hours worked by a different machine, because the rest are working at full capacity already. This would have an impact on production.

    But yes, the point you made about a business not working to its full potential is right as well. A lot of time can be saved if it works at an increased capacity.
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    Spare capacity in an economy can be both good or bad.

    I assume if the spare capacity was due to an increase in the capital stock of an economy (investment) or increase in population (labour), this would mean that the productive potential of the economy is likely to be far higher than prior to this (represented by an outward shift in the LRAS curve). This type of increase in spare capacity is good, as investment is normally only undertaken when there is an expected return on investment (due to rational behaviour) so it is likely this spare capacity will be used in the short to medium term. So as long as AD, as predicted is also constantly expanding so that actual economic growth can keep up with the increase in potential economic growth of the economy caused by investment, this will be considered a good thing as it means the economy can achieve a constant and sustained increase in Real GDP.

    When spare capacity in an economy is bad is when this spare capacity is not caused by increased investment (increased capital stock of the economy) or factor of production but by a reduction in AD or in other words economic decline / recession. This type of spare capacity renders once fully employed labours unemployed and makes capital redundant yet also at the same time reduces the productive potential of the economy over the long term by hysteresis (loss of skills) - which in fact reduces the spare capacity.

    The above is just my opinion, Im guessing that it would be similar for businesses as well.
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    (Original post by Oceancity)
    This question has baffled me for some time now, and I'm aware it's quite simple - but is spare capacity good or bad for an economy/nation/firm?

    Spare capacity could mean a business is able to match a change in quantity demanded, but also means that they aren't as productively efficient as they could be.

    In fact there are many effects of spare capacity, I am ultimately wondering if the benefits of having spare capacity outweigh the costs.

    Furthermore, does "operating with spare capacity" mean using the remaining spare capacity or operating at a level that leaves some spare capacity?

    Cheers.
    Operating with spare capacity means operating at a level that leaves some spare capacity.

    Key thing to this question is separate out the supply and demand side. Spare capacity is talking about supply: there is the capacity to adjust upwards to higher demand than current demand. Generally this is a good thing, although if there's a problem of below-normal demand in the economy then you might want to address that.

    It's not about productive efficiency. What you are thinking about is a firm producing at a level below its pareto optimal efficient use of its inputs, which is an issue of supply. Spare capacity is an issue of demand - the firm can supply more if demand rises but at the moment it's got spare capacity because the demand isn't there.

    Spare capacity is important in things like energy markets. Demand is variable at different times of the day and year. So we need our energy producers to have some spare capacity in the system ie be able to produce some more if demand goes up. When we reach a level where that spare capacity is eaten away then we have an energy shortage - people will want energy and the firms won't be able to produce enough. In a free market price will rise and this would effectively ration a scarce resource like energy to those that can afford it and the rest will live in the cold and dark. So effectively rising prices will deal with a situation where we have excess of demand relative to supply, the higher prices drive demand back down.

    This is why at a macro level, spare capacity in the economy is important in terms of inflation. If the economy has spare capacity then it can sustain an increase in demand without inflationary pressures. If it doesn't have spare capacity and demand increases, you are going to get rising inflation.
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    As above.

    Supply and demand work in most markets. A lot of it comes down to bargaining power. If there is excess labor lying around, wages will stay low. If there is excess factory space, prices for goods will stay low. Excess housing inventory, rents will stay low. Etc.

    That is the strategic side. Just looking at one player and not considering prices on product, you might want to weigh the benefits of flexibility of being able to raise production on one side vs. the cost of keeping that extra capital around on the other. Sort of like the newsboy problem. Too many extra copies on the stand, you eat up profit. Too few, you miss sales on a busy day.
 
 
 
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