Selecting the manufacturing capacity of a new product

To make a sensible decision on the optimum manufacturing capacity to be installed it is important to consider how demand may change with price, particularly for a new product. Using a simple cost and cash flow model, in which the pattern of demand in future time periods is specified by price, this article points out that, for any single future price, the only capacities which can be optimal are those which exactly meet the future demands at that price. Thus the search for optimal capacity and price is reduced to considering a finite and limited number of capacities, instead of a continuous range, for all possible prices. Although it is frequently optimal to install capacity equal to the ultimate potential demand at the optimum price, the article notes occasions when optimal capacity is lower than this and gives an example where the demand of only three time-periods hence should be partially foregone even at a zero discount rate, which penalises most the foregoing of future demand.