Asked by Emily Gellis on Jul 22, 2024
Verified
The Happy Mountain Brewing Company sells ground organic coffee in one pound containers through several grocery chains in the US. The firm has two divisions: the roasting division buys raw organic coffee beans and then blends, roasts, and grinds the beans, and the merchandising division packages and distributes the ground coffee.
a. Please draw a carefully labeled figure that illustrates the optimal transfer pricing policy for the firm if there is no outside market and the firm is a monopoly seller (i.e., there are no other sellers of ground organic coffee). In particular, please show the optimal transfer price that is paid to the roasting division, the optimal retail price charged by the merchandising division, and the optimal amount of coffee sold.
b. Suppose poor weather conditions in South American increase the price of raw coffee beans. How does this affect the marginal cost curve for the roasting division? Does this also affect the marginal cost of merchandising (packaging and distribution)? How do the optimal transfer price, retail coffee price, and quantity sold change due to this weather problem?
Transfer Pricing Policy
A set of regulations and procedures that multinational companies use to set prices for transactions between their different legal entities.
Vertical Integration
Organizational form in which a firm contains several divisions, with some producing parts and components that others use to produce finished products.
Monopoly Seller
A business entity that is the sole provider of a particular good or service, giving it significant control over the market price.
- Understand the concept of optimal transfer pricing in a monopolistic market.
- Analyze the impact of external factors such as raw material cost changes on optimal transfer pricing and overall firm strategy.
Verified Answer
b.Under this scenario, the marginal cost of roasted coffee shifts upward, and the marginal cost of merchandising does not shift. Accordingly, the net marginal revenue curve does not shift, but the optimal quantity of coffee production declines due to the upward shift in the marginal cost of roasting. The optimal transfer price for roasted coffee increases, and the optimal retail price of coffee also increases due to the decline in the profit maximizing quantity of coffee.
Learning Objectives
- Understand the concept of optimal transfer pricing in a monopolistic market.
- Analyze the impact of external factors such as raw material cost changes on optimal transfer pricing and overall firm strategy.
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