Thought Experiment Transfer Pricing Alternatives in Corporation under Demand Fluctuations
- 1 Ariel University, Ariel, Israel
Abstract
The object of this study is to compare numerical results for a hypothetical nu merical model comparing transfer pricing alternatives of a multi-division corporation selling cement facing demand fluctuations, prosperity versus depression, with two alternate technologies, high fixed cost versus low fixed costs. The transfer pricing alternatives: A) short-run marginal cost pricing high price volatility over the business cycle versus B) John M. Clark’s workable competition pricing low price volatility over the business cycle. The article is a thought experiment in economics, carried out only in the imagination. The article presents a detailed numerical model of a two-division corporation having a manufacturing division that produces cement and a marketing division that sells cement from the manufacturing division. In the model cement manufacturing plants have linear total cost functions with absolute capacity restrictions. The article considers two alternative technologies: 1) plant L old plants with low fixed costs but high marginal costs and 2) plant K new plants with high fixed costs and low marginal costs. In opposition to marginal cost theory, this study argues in support of John M. Clark (1884-1963) workable competition theory. The study assumes frequency of off periods 6/7 and frequency of peak periods 1/7. The study claims, under the assumptions of the model, workable competition transfer pricing B adds to consumer surplus and to corporate profits over the cycle in comparison to marginal cost pricing A because the gains in consumer surplus in peak demand times 1/7 frequency with more output and lower prices will outweigh the loss in consumer surplus and to corporate profits in off-peak times 6/7 with higher prices and lower output. The gains in prosperity times, though infrequent 1/7, are large, especially with relatively elastic demand curves. The loss in depression times, though frequent 6/7 are small, especially with inelastic demand curves.
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