Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

270 RECENT AND ADVANCED TOPICS IN MARKET STRUCTURE [CHAP. 11
(b)
The gain in shifting from constant pricing to peak-load pricing (shown by the sum of the two shaded triangles
in Fig. 11-6) is smaller when substitution in consumption is taken into account than when it is not. The reason
is that the demand curves differ less with peak-load pricing when substitution in consumption is taken into
account than when it is not.
COST-PLUS PRICING
11.14 Starting with MR ¼ P(1 2 1/e), where MR equals marginal revenue, P is commodity price, and e is the
price elasticity of the demand for the commodity sold by the firm, derive the formula for the markup that
maximizes the firm’s total profits in terms of the price elasticity of demand.
Starting from MR ¼ P(1 2 1/e) and solving P, we get P ¼ MR/(1 2 1/e). Since profits are maximized where
MR ¼ SMC, we can substitute SMC for MR in the above formula and get P ¼ SMC/(1 – 1/e).
To the extent that the firm’s SMC is constant over a wide range of outputs, SMC ¼ AVC. Substituting AVC for
SMC in the above formula, we get P ¼ AVC/(1 2 1/e). This last formula equal P ¼ AVC(1 þ m)ifm ¼ 1(e 2 1).
11.15 What should be the markup (m) for a firm to maximize its total profits if the price elasticity e of demand
for the commodity sold by the firm is (a) e ¼ 2? (b) e ¼ 3? (c) e ¼ 4? (d) e ¼ 5?
(a) If e ¼ 2, m ¼ 1/(e –1)¼ 1(2 – 1) ¼ 1 or 100%.
(b) If e ¼ 3, m ¼ 1(3 – 1) ¼ 0.5 or 50%.
(c) If e ¼ 4, m ¼ 1/(4 – 1) ¼ 0.33 or 33%.
(d ) If e ¼ 5, m ¼ 1/(5 – 1) ¼ 0.25 or 25%.
TRANSFER PRICING
11.16 (a) Explain what has stimulated the growth of the large scale-modern enterprise. (b) Indicate what
organizational development was introduced in order to contain the tendency toward rising costs.
(c) Indicate the problem to which this has led. (d) Explain why it is important to solve this problem.
(a) The growth of the large-scale modern enterprise has been stimulated by economies of scale in production (i.e.,
by the opportunity of taking advantage of very large cost reductions with large-scale or mass production) and
by the tremendous improvements in communications.
(b) The rapid rise of the large-scale enterprise has been accompanied by decentralized operations and the establishment
of semi-autonomous profit centers in order to contain the tendency toward rising communications
and organizational costs.
(c) Decentralization and the establishment of semi-autonomous profit centers also led to the transfer pricing
problem. Transfer pricing refers to the pricing of intermediate products sold by a semi-autonomous division
of the firm and purchased by another semi-autonomous division of the firm.
(d ) Appropriate transfer pricing is essential in determining the optimal output of each division and of the firm as a
whole, in evaluating divisional performance, and in determining divisional rewards.
11.17 Explain how the price of an intermediate product is determined when there is no external market for the
product.
In the absence of an external market for the intermediate product, the transfer price for the intermediate product
is given by the marginal cost of the production division at the best level of output for the intermediate product. If one
unit of the intermediate product is required to produce each unit of the final product, the best level of output of the
intermediate product is equal to the best level of output of the final product.
11.18 The Digital Clock Corporation is composed of two semi-autonomous divisions—a production division
that manufactures the moving mechanism for digital clocks and a marketing division that assembles and
markets the clocks. There is no external market for the moving parts of the clocks manufactured by the
production division. The external demand and marginal revenue functions for the finished product (i.e.,