Strategic Transfer Pricing and Social Welfare under Product Differentiation

Abstract

In this paper, we investigate the social impacts of strategic transfer pricing by oligopoly firms, aiming to derive regulatory implications for transfer prices. A notable finding from our model is that the negative effects on social welfare of transfer prices being set above marginal cost are pronounced when either (1) the number of competing firms is large and the product is relatively highly differentiated or (2) the number of firms is small and the product is not very differentiated. This result indicates that even when the number of firms in the industry is significant and the market is thus apparently competitive, the authorities should not overlook the possibility that setting transfer prices above marginal cost might seriously damage social welfare if the product is highly differentiated.

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