Current (3 furnaces) Projected (4 furnaces) Annual output (tonnes) 180,000 243,000 Total production costs ($m) 54.0 68.0 Average cost per tonne ($) 300 280 ...

(a) Economies of scale are the cost advantages that a business gains when it increases its scale of production, resulting in a lower average cost per unit of output. As a business grows larger, it can spread fixed costs over more units and benefit from efficiencies that smaller producers cannot achieve. [2 marks: 1 for cost advantages from increased production, 1 for lower average/unit cost]

(b) Two purchasing economies of scale Kravchenko Steel Works might benefit from:

1. Bulk-buying discounts on raw materials. By ordering larger quantities of iron ore and coal (the key inputs for steel production), Kravchenko can negotiate lower prices per tonne from suppliers. The increased output from a fourth blast furnace would significantly increase raw material orders, giving the company stronger bargaining power. [2 marks]
2. Lower transport costs per unit. Larger shipments of finished steel bars and sheets to construction firms mean that each full truckload or rail car costs less per tonne to transport than a partially filled one. The fixed cost of each delivery journey is spread across more units of output. [2 marks]

(c) Building a fourth blast furnace could lead to diseconomies of scale for several reasons:

• Communication becomes slower and less effective. The table shows management layers would increase from 4 to 6 with the expansion. More layers mean messages must pass through more intermediaries between senior management and factory floor workers, increasing the chance of delay, distortion, and misunderstanding. The company already experiences slow communication between departments.
• Coordination difficulties increase. Managing four blast furnaces, 3,100 workers, and six management layers requires significantly more complex scheduling, supervision, and logistics than the current operation. Managers may lose direct contact with production processes, making it harder to identify and respond to quality problems or equipment failures quickly.
• Worker motivation may decline. In a much larger organisation, individual workers may feel less valued and less connected to the company's goals. This can reduce productivity and increase absenteeism, raising costs per unit of output and potentially offsetting the savings from higher production volume.

The table already shows early evidence: the proposed expansion from 2,400 to 3,100 employees and from 4 to 6 management layers suggests the organisational structure is becoming more complex, which is a classic trigger for diseconomies. [6 marks]

(d) Arguments for expansion:

• A 35% output increase could significantly reduce average costs if economies of scale outweigh diseconomies. The table confirms average cost per tonne would fall from $300 to $280.
• Growing demand for steel in Eastern European construction markets provides a revenue opportunity. If Kravchenko does not expand, competitors may capture the growing demand instead.
• The $20 per tonne cost reduction across 243,000 tonnes represents a potential annual saving of $4.86 million in production costs.

Arguments against:

• Managers already report that coordination is difficult and communication is slow. Adding a fourth furnace and 700 more workers would intensify these problems. The increase from 4 to 6 management layers is a clear warning sign.
• The capital investment in a fourth blast furnace is very substantial and ties up funds that could be used for other purposes, such as upgrading existing furnaces or improving worker training.
• If construction demand declines (due to an economic downturn, for example), the company would face overcapacity and high fixed costs with no revenue to justify them.

Conclusion: The expansion depends on two conditions: whether market demand forecasts are reliable, and whether the management structure can be reformed to handle the larger scale. If Kravchenko invests in improved communication systems and management training alongside the new furnace, the $20 per tonne cost reduction makes expansion financially attractive. Without addressing the existing coordination problems, the expansion risks creating diseconomies that erode the cost advantage. [8 marks]