610-05 - Monday, October 6 th • Topics: – Decision...

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Unformatted text preview: Monday, October 6 th • Topics: – Decision Making: Make or Buy and Transfer Pricing – Double Marginalization and Vertical Integration – Relevant Costs • Readings: – Brickley et. al, Chapter 19:562-574; – Hoyt, Lecture 3:115-126 Monday, October 13 th • 1 st Half: Review for Exam • 2 nd Half: Exam Vertical Integration The modern corporation is often organized into a number of different divisions that are vertically integrated. Vertical integration implies a structure in which the product developed in the "upstream" division is an input in production in a "downstream" division. Examples: – Automobile production – Engines are produced in one division of GM and then purchased by another a division that assembles the automobile. Why have vertical integration? Enables a corporation to monitor and reward production more easily by rewarding division based on the "profits" generated by that division. Upstream division that "sells" its products to downstream division needs a price for its product. Reasons: – To accurately measure division profit and evaluate the overall success of the firm. • To motivate divisions by giving them a chance to earn profits based on their performance. • To ensure the proper production and allocation of "upstream" products to "downstream" divisions or external markets. • To minimize international tax liabilities. An Example with External Market Company produces electronic control devices and specialty microchips. – ATC is $300 and P c = 550. – Company uses chips in control devices. – ATC of device (ATC d ) is $500 + 2*ATC c = $1100 and P d = $1,500. Assume the $500 is variable. Should the company produce control devices? • Two Scenarios: – Outside orders for chips were insufficient to keep capacity utilized. – Suppose that $200 of the devices costs are fixed and capacity could be fully-utilized by outside orders. Should the firm produce chips in the short run? Choosing the Transfer Price Example: 2 divisions “upstream" and downstream. – The upstream produces a component by the downstream division for sale on an external market. What should the price of the component (p C ) be? To answer -- the overall objective of the corporation is to maximize its profits, not the profits of any single division....
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This note was uploaded on 01/13/2012 for the course ECONOMICS 610 taught by Professor Staff during the Fall '11 term at Gateway Tech.

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610-05 - Monday, October 6 th • Topics: – Decision...

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