Production Unit

In the circular flow diagram found in most principles of economics texts, production takes place in a "firm" or "business." When considering the production-cost relationships it is important to distinguish between firms and plants. A plant is a physical unit of production. The plant is characterized by physical units of inputs, such as land (R) or capital (K). This includes acres of land, deposits of minerals, buildings, machinery, roads, wells, and the like. The firm is an organization that may or may not have physical facilities and engage in production of economic goods. In some cases the firm may manage a single plant. In other instances, a firm may have many plants or no plant at all.

The cost functions that are associated with a single plant are significantly different from those that are associated with a firm. A single plant may experience economies in one range of output and diseconomies of scale in another. Alternatively, a firm may build a series of plants to achieve constant or even increasing returns.

General Motors Corp. is often used as an example of an early firm that used decentralization to avoid rising costs per unit of output in a single plant.

Diversification is another strategy to influence production and associated costs. A firm or plant may produce several products.

Alfred Marshall (one of the early Neoclassical economists in the last decade of the 19th century) considered the problem of "joint costs. " A firm that produces two outputs (beef and hides) will find it necessary to "allocate" costs to the outputs.

Unless specifically identified, the production and cost relationships will represent a single plant with a single product.