Optimal capacity with stochastic demand

A model focusing on the choice of capacity in an environment with stochastic demand is presented. The paper establishes the conditions under which bias in traditional econometric measures of capacity utilization may occur. As illustration, the model is applied to the Norwegian vessel-building industry. The results from traditional econometric studies in this industry are adjusted using the results from the model presented. The analysis indicates an upward bias in the traditional capacity utilization index; the excess capacity in the analyzed industry, as determined by deviation from the optimal, stochastically-adjusted level of capacity, is higher than that determined by traditional econometric measures. However, the author is reluctant to draw definitive conclusions from the empirical part of the paper due to uncertainty regarding data and assumptions made. The empirical implementation is primarily illustrative and should be interpreted as such.