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

Forthcoming in the Global Journal of Economics, March 2013, Vol. 02, No. 01, (doi: 10.1142/S2251361213500031)

26 Pages Posted: 17 Oct 2012 Last revised: 10 Sep 2016

Winston W. Chang

State University of New York at Buffalo - Department of Economics

Han Eol Ryu

Korea Institute for Industrial Economics and Trade

Date Written: September 14, 2013

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.

Keywords: optimal transfer pricing, vertically related models, multinational firms, international taxation, strategic competition, demand characteristics

JEL Classification: D43, D49, L13, L22, M21

Suggested Citation

Chang, Winston W. and Ryu, Han Eol, Optimal Transfer Pricing: Competition Mode, Demand and Strategic Characteristics, and Production Technology (September 14, 2013). Forthcoming in the Global Journal of Economics, March 2013, Vol. 02, No. 01, (doi: 10.1142/S2251361213500031). Available at SSRN: https://ssrn.com/abstract=2161925 or http://dx.doi.org/10.2139/ssrn.2161925

Winston W. Chang (Contact Author)

State University of New York at Buffalo - Department of Economics ( email )

453 Fronczak Hall
Department of Economics, SUNY at Buffalo
Buffalo, NY 14260
United States
716-645-8671 (Phone)
716-645-2127 (Fax)

HOME PAGE: http://economics.buffalo.edu/facultyprofiles/winston-chang/

Han Eol Ryu

Korea Institute for Industrial Economics and Trade ( email )

370, Sicheong-daero,
Sejong-Si, 339-007
Korea, Republic of (South Korea)
82-44-287-3248 (Phone)

HOME PAGE: http://www.kiet.re.kr

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