Managerial Economics

Problem for Transfer Pricing: To be Discussed in Class with Students Leading the Discussion (so be prepared)

The market demand in the downstream market for Acme's product is

PD = 100 - 2QD

where PD is the price of a unit of the downstream product and QD is the number of units of the downstream product demanded at that price.

The total cost of Acme's downstream plant (TCD) exclusive of the cost of the upstream input is

TCD = 10 + 20QD + 2QD2

where QD is the number of units produced by Acme's downstream division.

Acme has an upstream division that provides them with an exclusive input. No other firm produces this product and no other firm demands this product. It takes one of the upstream product to produce one unit of the downstream product. The upstream firm's total cost (TCU) is

TCU = 14 + 10QU + QU2

where QU is the number of units produced by Acme's upstream division.

What is the optimal transfer price between the upstream and downstream firms for a unit of the upstream product? How many units are produced? What are the profits of the upstream and the downstream divisions?

Suppose that the two firms are located in different countries and that the income tax in the downstream country is 50% and the income tax in the upstream country is 25%. What might you expect in terms of the transfer price? How does this help the conglomerate