Transfer and peak load pricing technique

Transfer and peak load pricing technique

1. Definition Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control.  Wikipedia Transfer pricing is defined as the determination of price of intermediate product sold by one semiautonomous division of the same product.

2. Production. Research and Development (often abbreviated to R&D) Purchasing. Marketing (including the selling function) Human Resource Management. Accounting and Finance.

3. If the decision makers in each division attempt to maximize profit for their units, the total profit of the firm might be reduced . So, the price of intermediate product should be set so as to maximize overall profit rather than divisional profit.

4. Example Marketing Department Production Department Pricing of compressor is transfer pricing

5. Transfer Pricing without External Market Total production of Pro. Dep. (Total No. of Compressor produced by A firm) Marketing Division Supplies to No External Market for Compressor

6. Diagram AR MR MC(M) MC(P) MC= MCp + MCm E Pm Pt o Q(M) = Q(P)

7. Transfer pricing when external market exists Total production of Pro. Dep. (Total No. of Compressor produced by A firm) Supplies to Marketing Division External Market

8. Diagram AR MR MC(M) MC= MCm + Pt E P Pt o Q D(P) = MR(P) Q(P)

9. Peak-load Pricing It is a form of inter-temporal price discrimination based on efficiency. For goods and services, demand peaks at particular times — for roads and public transport during commuter rush hours, for electricity during late afternoon and so on. Peak Load Pricing  is a  pricing  strategy that implies  price  will be set at the highest level during times when  demand  is at a  peak . The  pricing  strategy is an attempt to shift  demand , or at least consumption of the good or service, to accomodate supply.

10. MC is also high during these peak periods because of capacity constraints. Prices should, thus, be higher during peak periods  For example, a movie theatre, which charges more for the evening show than for the matinee show because for theatres, the MC of serving customers during the matinee show is independent of the MC during the evening.

11. The owner of a movie theatre can determine the optimal prices for the evening and matinee shows independently, using estimates of demand in each period and of MC.

12. Merits Peak load pricing would help balance capacity usage. Reducing growth in peak load. Decreasing the need for capacity expansion, through charging customers in peak time a higher peak price. Shifting part of the load from the peak to the base load plants which called valley filling and charging off peak customer a lower off peak price, thus having some savings in used fuels during peak time.

13. Demerits 1. The investment cost of installing time-sensitive measuring equipment. The new technology may entail switching costs. Producers may also have to hire field personnel and supervisors 2. Introducing PLP has some costs that need to be taken into consideration and must be weighed against the welfare gains of more efficient pricing. PLP requires sophisticated measurement of customer usage and advanced metering. Many utilities may lack information that allows differential pricing across periods of consumption and would therefore need to upgrade metering equipment so as to introduce PLP. 3. The drawback of this theory is that it abstracts from a more general behaviour in which at least some consumers may choose to shift their demand from one season to another in response to a lower price during their “less desirable” season. 4. False prediction leads to wrong pricing regulation