Pricing of joint products and transfer pricing
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Pricing of Joint Products and Transfer Pricing. Web Appendix 9B. Slides developed by: William Rentz & Al Kahl University of Ottawa. Joint Products. Interdependencies in costs occur in products that are produced simultaneously or jointly.

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Pricing of joint products and transfer pricing l.jpg

Pricing of Joint Products and Transfer Pricing

Web Appendix 9B

Slides developed by:

William Rentz

& Al Kahl

University of Ottawa

© 2006 by Nelson, a division of Thomson Canada Limited


Joint products l.jpg
Joint Products

  • Interdependencies in costs occur in products that are produced simultaneously or jointly.

    • E.g., Beef & Hides in steers and Natural Gas & Crude Oil in oil well drilling are ‘jointly produced’.

  • Suppose beef & hides are produced in FIXED PROPORTIONS : 250 kilos of Beef + 7.5 square metres of hides for 1 steer.

    • Two cases: (1) No excess of either product and (2) one product has an excess.

© 2006 by Nelson, a division of Thomson Canada Limited


Steers the case with no excess of either hides or beef l.jpg
Steers:The Case with No Excess of Either Hides or Beef

Two Demand

Curves:

Hides (H) & Beef (B)

Two MR Curves:

Hides & Beef

MRB

DH

DB

© 2006 by Nelson, a division of Thomson Canada Limited

steers (T)

MRH


Slide4 l.jpg

2

MCT

MRT

Find where

MRT = MCT

to find the

optimal of

steers.

DH

DB

© 2006 by Nelson, a division of Thomson Canada Limited

steers (T)

MRH


Slide5 l.jpg

3

MRT

MCT

At the optimal number of

steers, find

the prices of beef & hides on their

respective

demand curves

PB

PH

DH

DB

© 2006 by Nelson, a division of Thomson Canada Limited

steers (T)

MRH

T


Suppose the atkins diet encourages more demand for beef l.jpg
Suppose the Atkins’ Diet encourages more demand for beef

  • Demand for beef shifts up and out

  • MR for steers shifts up and out

  • The optimal number of steers rises

  • The price of beef rises, but…

    the price of hides declines.

© 2006 by Nelson, a division of Thomson Canada Limited


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Excess of One of the Joint Products

  • Excess means the price would be ZERO

  • The solution is to hold back some of the excess to reach the Unit Elastic Point on the Demand Curve.

  • This Maximizes Total Revenue.

© 2006 by Nelson, a division of Thomson Canada Limited


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Transfer Pricing

  • Vertically integrated firms “sell” intermediate goods from one division to the other. The internal price used is called the transfer price.

Car Frames

Fisher

Body

GM

Chevy

Division

Transfer prices paid

Fisher Body Car Frames

(a division of GM) sells

to Chevrolet (another

division of GM)

GM Chevrolet Division

Buys Fisher Body Car Frames

© 2006 by Nelson, a division of Thomson Canada Limited


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  • Transfer Pricing serves two functions:

  • 1. It measures the marginal value of the resource

  • It provides a performance measure of resources used, including the totalvalue of resources

    • Each division can be a profit centre.

For International Firms, transfer pricing may assist in

reducing worldwide taxation, although ability to reduce

taxes is limited since the CRA requires arm’s length prices.

© 2006 by Nelson, a division of Thomson Canada Limited


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Create Transfer Prices Similar to Competitive Market Prices

  • Disagreementsacross divisions are common

    • “Selling” Division wants a HIGH transfer price!

    • “Buying” Division wants a LOW transfer price!

  • When External Markets exist, use those prices for transfer (a market-based competitive price)

sell to others @ “P”

final car

assembly

motor assembly

purchase motors from others @ “P”

© 2006 by Nelson, a division of Thomson Canada Limited


Optimal transfer pricing l.jpg
Optimal Transfer Pricing

© 2006 by Nelson, a division of Thomson Canada Limited


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