Competitive External Market with Excess Internal Demand

To consider the effects of an external market for the transferred product, assume that the company is able to buy an unlimited quantity of a comparable product from a foreign supplier at a price of $35. The product supplied by the foreign manufacturer meets the exact same specifications as that produced by Josiah Bartlet & Sons. Because an unlimited quantity can be purchased for $35, a perfectly competitive external market exists for the transferred product, and the optimal transfer price equals the external market price. For PT = $35, the quantity demanded by the distribution division is

whereas the quantity supplied by the manufacturing division is

PT = MCMfg $35 = $20 + $0.002Q 15 = 0.002Q Q = 7,500

In this case of excess internal demand, the distribution division will purchase all 7,500 units produced internally plus an additional 12,500 units from the foreign supplier. The price impact for customers and the profit impact for Josiah Bartlet & Sons are dramatic. Domestic customer prices and total profits are now calculated as

= $100(20,000) - $0.001(20,0002) - $250,000 - $20(7,500)

- $0.001(7,5002) - $35(12,500) - $62,500 - $5(20,000)

Josiah Bartlet & Sons' domestic customers benefit from the increased availability of goods, 20,000 versus 15,000 units, and lower prices, $80 versus $85 per unit. The opportunity to purchase goods at a price of $35 from a foreign supplier benefits the company because profits grow from $250,000 to $343,750. The firm now manufactures only 7,500 of the units sold to customers and has become much more of a distributor than an integrated manufacturer and distributor. Josiah Bartlet & Sons has been able to make its business and profits grow by focusing efforts on distribution, where it enjoys a comparative advantage.

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