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INCREASED OVERHEAD Suppose the microchip manufacturer’s overhead

costs (for the physical plant and administration) increase. Fixed costs were

$100,000 per week; now they are $112,000. How will this affect the firm’s oper-

ating decisions? The simple, albeit surprising, answer is that the increase in

fixed costs will have no effect whatsoever. The firm should produce and sell

the same output at the same price as before. There are several ways to see this.

First, note that the firm’s profit is reduced by $12,000 (relative to its profit

before the cost increase) whatever its level of output.Thus, whatever output was

profit-maximizing before the change must be profit-maximizing after it.

Second, the revenue and cost graphs in Figure 2.8a provide a visual confirma-

tion of the same reasoning. An increase in fixed cost causes the cost line to

shift upward (parallel to the old one) by the amount of the increase. At any

output, the revenue-cost gap is smaller than before. But note that the point

of equal slopes—where MR MC and the profit gap is maximized—is

unchanged. Profit is still maximized at the same output as before, Q 3.3.

Finally, the MR and MC curves in Figure 2.9a make the same point. Has the

increase in fixed cost changed the MR or MC curves? No! Thus, the firm’s opti-

mal output, where the MR and MC lines intersect, is unchanged.

INCREASED MATERIAL COSTS Silicon is the main raw material from which

microchips are made. Suppose an increase in the price of silicon causes the

firm’s estimated cost per lot to rise from $38,000 to $46,000. How should the

firm respond? Once again the answer depends on an appeal to marginal analy-

sis. In this case, the firm’s MC per chip has changed. In Figure 2.9b, the new

MC line lies above and parallel to the old MC line. The intersection of MR and

MC occurs at a lower level of output. Because producing extra output has

become more expensive, the firm’s optimal response is to cut back the level

of production. What is the new optimal output? Setting MR MC, we obtain

170 40Q 46, so Q 3.1 lots. In turn, the market-clearing price (using

Equation 2.2) is found to be $108,000. The increase in cost has been partially

passed on to buyers via a higher price.

INCREASED DEMAND Suppose demand for the firm’s chips increases dra-

matically. At the higher demand, the firm could raise its price by $20,000 per

lot ($200 per chip) and still sell the same quantity of chips as before. The old

price equation was P  170 20Q. The new price equation is P  190 20Q.

What should be the firm’s response? Here the increased demand raises the

marginal revenue the firm obtains from selling extra chips. In fact, given the

new price equation, the new MR equation must be MR  190 40Q. Thus, the

new MR curve in Figure 2.9c has a larger intercept than the old one, although

the slope is the same. The upward, parallel shift in the MR curve means the new

intersection of MR and MC occurs at a higher output. What is the new optimal

output? Setting MR MC, we find that 190 40Q 38, so Q 3.8 lots. The

corresponding market-clearing price (using the new price equation) is

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