TITLE:
Thought Experiment Transfer Pricing Alternatives in Corporation under Demand Fluctuations
AUTHORS:
Gerald Aranoff
KEYWORDS:
Transfer Pricing, Manufacturing, Business Cycle, Peak-Load Pricing, Cutthroat Competition, Workable Competition
JOURNAL NAME:
Modern Economy,
Vol.13 No.5,
May
27,
2022
ABSTRACT: The object of this study is to
compare numerical results for a hypothetical numerical 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) plantL old plants with low fixed costs but high marginal costs and 2) plantK 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.