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Optimal Transfer Pricing: Competition Mode, Demand And Strategic Characteristics, And Production Technology

Author

Listed:
  • WINSTON W. CHANG

    (Department of Economics, SUNY at Buffalo, Buffalo, NY 14260, U.S.A.)

  • HAN EOL RYU

    (Department of Economics, SUNY at Buffalo, Buffalo, NY 14260, U.S.A.)

Abstract

The objective of this paper is to find the key factors that affect a firm's optimal transfer pricing policy. It examines two minimalist vertical models — one consisting of a vertically integrated firm monopolizing an intermediate input for its own and rival's downstream division, and the other comprising two vertically integrated firms competing in a final goods market. Four modes of competition are considered — Cournot, Bertrand, Stackelberg quantity, and price. The paper shows that, in addition to the usual tax considerations, the optimal transfer pricing policy depends on competition mode, demand and strategic characteristics, vertical structure, and production technology. For example, under the same demand structure and competition mode, the two models can yield diametrically opposite outcomes; within a given vertical model, different competition modes may yield different optimal strategies; and within a given competition mode, the four pairings of ordinary substitutes/complements and strategic substitutes/complements can also produce quite different results. The general structure analyzed in this paper can be applied to other transfer pricing models involving uncertainty, cost sharing, asymmetric information, etc. that have been mainly studied in the literature under specific competition modes and demand and strategic characteristics.

Suggested Citation

  • Winston W. Chang & Han Eol Ryu, 2013. "Optimal Transfer Pricing: Competition Mode, Demand And Strategic Characteristics, And Production Technology," Global Journal of Economics (GJE), World Scientific Publishing Co. Pte. Ltd., vol. 2(01), pages 1-21.
    • Handle: RePEc:wsi:gjexxx:v:02:y:2013:i:01:n:s2251361213500031
    DOI: 10.1142/S2251361213500031
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    References listed on IDEAS

    as
    1. Oliver Hart & Jean Tirole, 1990. "Vertical Integration and Market Foreclosure," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990 Micr), pages 205-286.
    2. Hines, J.R., 1990. "The Transfer Pricing Problem: Where The Profit Are," Papers 64, Princeton, Woodrow Wilson School - Discussion Paper.
    3. Korn, Evelyn & Lengsfeld, Stephan, 2007. "Duopolistic Competition, Taxes, and the Arm's-Length Principle," Hannover Economic Papers (HEP) dp-378, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
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    More about this item

    Keywords

    Optimal transfer pricing; strategic competition; vertically related models; demand characteristics; international taxation; multinational firms; JEL Classifications: D43; JEL Classifications: D49; JEL Classifications: L13; JEL Classifications: L22; JEL Classifications: M21;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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