Decentralized pricing of differentiated products: Implications for industry analysis

When price setting is decentralized within a multidivisional firm and decision makers face local incentives, observed product prices are often—but not always—greater than firm-level optimal prices. The information that can be inferred from observed prices in empirical studies of differentiated product industries depends on the organizational structure of the firm. The interaction of the transfer pricing method employed by the firm and characteristics of the firm's organizational form, such as the number of downstream divisions and the number of products sold in each division, determines the nature of the distortion to final good pricing. This paper describes when information about firm structure and transfer pricing method is particularly valuable for modeling firm behavior in industry-level analysis.