10.6.3 Products with perfectly competitive external markets
Having considered the situation where there is no external market, it is now time to examine the situation where there is a perfectly competitive external market. In this situation the intermediate product can either be sold by the manufacturing division to another firm, or bought by the marketing division from another firm, at a fixed price. The optimal transfer price is the same as the external market price. If the transfer price were lower than this, it would be more profitable for the manufacturing division to sell the product externally, while if the transfer price were higher than this, it would be more profitable for the marketing division to buy the product externally.
One major difference between this situation and the one where there is no external market is that there may well be a mismatch between the amount that the manufacturing division wants to sell and the amount that the marketing division wants to buy. If the former exceeds the latter, then the excess can be sold on the open market, while if the latter exceeds the former, the excess can be purchased on the open market.
10.6.4 Products with imperfectly competitive external markets
This case is somewhat more complex than when external markets are perfectly competitive. The optimal transfer price this time equates the marginal cost of the manufacturing (transferring) division to the marginal revenue derived from the combined internal and external markets. The resulting optimal output is divided between internal transfers and external sales. The amount that is transferred internally is determined by equating the marginal cost of the manufacturing division with the net marginal revenue from final product sales:
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The amount of the intermediate product that is sold in the external market is determined by equating the marginal cost of the manufacturing division with the marginal revenue from sales in the external market:
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