Transfer Pricing

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Transfer Pricing with No Outside Market

  • In general in these problems we will be given Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle MC_u} which will be the marginal cost for the upstream firm and Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle MC_d} which will be the marginal cost for the downstream firm.
  • We also define Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle P_T} as the transfer price between the downstream firm and the upstream firm. The downstream firm will be paying the upstream firm this transfer price for every good that he produces.
  • To optimize profit, we set Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle P_T = MC_u}
  • Therefore, to find the quantity that maximizes profit we set Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle MR = MC_u + MC_d}

Transfer Pricing with Competitive External Market

  • In this case, the marginal cost for the activities of the upstream firm is still Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle MC_u} but the marginal cost for the supplies of the downstream firm, Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle MC_d} , is now the competitive external price of the of the supplies.
  • Therefore to optimize profit the downstream firm should set Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle MR = MC_d + P_c} where Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle P_c} is the price of the upstream goods in a competitive market.
  • The downstream firm should set Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle P_c = MC_u}
  • Alternatively, it is possible to maximize profits by calculating Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle Profit = P_f * Q_f - TC_f - TC_i + P_c * (Q_i - Q_f)} , where "i" stands for intermediate good and "f" stands for finished good.
  • Next we take Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle \frac{dProfit}{dQ_i}} and set it equal to zero to find the optimum quantity of intermediate goods.
  • Finally, we take Failed to parse (MathML with SVG or PNG fallback (recommended for modern browsers and accessibility tools): Invalid response ("Math extension cannot connect to Restbase.") from server "https://wikimedia.org/api/rest_v1/":): {\displaystyle \frac{dProfit}{dQ_f}} and set it equal to zero to find the optimum quantity of final goods.