ABSTRACT
In this paper the 'transfer price' is defined as the price that applies to intra-firm trade in tangible goods between affiliates of a multinational enterprise (MNE). Because the affiliates are related, the transfer price is an internal price to the MNE, serving to allocate profits between exporting and importing firms. In the absence of tariffs or corporate profit tax differentials constraining the MNE, Hirshleifer (1956) proved that the efficient or shadow transfer price should be marginal cost of the selling division. If a perfectly competitive outside market exists and there are no costs of transacting in this market, the MNE should set the shadow transfer price equal to market price. The shadow price is efficient in the sense that it induces a resource allocation between the divisions of the MNE that maximizes global MNE profits. Hirshleifer (1957) proved that this shadow transfer price is also the decentralized or arm's-length transfer price that would be chosen if the individual divisions of the MNE were run as profit centres and were required to maximize their separate profits.
