Utilization of optimal capacity in Indian manufacturing, 1974-1996

This paper attempts to estimate a consistent series for the economic capacity utilization of the Indian non-electrical machinery manufacturing sector. The economic or optimum capacity is defined as the output where the short-run average total cost is minimized. Using an iterative version of Zellner's seemingly unrelated regression estimation technique, a translog short-run cost function is estimated, imposing the conditions for economic optimizing behaviour of firms to calculate the optimal output. Such a measure assumes that variations in capacity utilization (CU), defined as the ratio of actual to optimal output, are the systematic results of rational optimization procedures, depending on price and cost conditions of firms. A comparison of the new series with the conventional engineering measures of CU shows that the widely used 'installed CU' figures clearly underestimate the true economic utilization levels, mainly due to definitional problems.