Capacity
The level of output that corresponds to the minimum short-run average
total cost is often called the capacity of the firm. When used in this sense,
capacity is the largest output that can be produced without encountering
rising average costs per unit. In part (ii) of Figure 7-2 , capacity output is
about 107 units, but higher outputs can be achieved, provided that the
firm is willing to accept the higher per-unit costs that accompany any
level of output that is “above capacity.” A firm that is producing at an
output less than the point of minimum average total cost is said to have
excess capacity.
This technical definition gives the word capacity a meaning that is
different from the one used in everyday speech, in which it often means
an upper limit that cannot be exceeded. The technical definition is,
however, a useful concept in economic and business discussions.
The cost curves we have been discussing are typical in an industrial
setting, such as for firms producing steel or newsprint or machinery or
even computers and smartphones. In these cases, the existence of a fixed
factor, such as a factory with a given amount of machinery and
equipment, usually leads to clear cases of diminishing marginal returns
and thus to the U-shaped cost curves as shown in Figure 7-2.