Compare the firm's profits before and after it is divided into two profit centers.
Firm B:
Damsung Company assembles television sets. The demand curve for its TV sets is given by P = 3,000 - 10Q, where Q is the number of TV sets sold and P is the price. The cost for assembly (which includes purchasing all parts) is equal to 500 x Q, so that the marginal cost of assembly is constant at $500. The distribution costs are equal to 50 x Q, so that the marginal cost of distribution is constant at $50. Damsung Company has no costs other than the costs for assembly and distribution.
Firm B:
Now assume that the firm is divided into two profit centers: the assembly division and the distribution division. The assembly division assembles the product at a total cost of 500 x Q and then transfers it to the distribution division that faces the firm's demand curve. The distribution division has no costs other than the transfer price and the distribution costs for the product. Assume that the assembly division has the power to set the transfer price and that the distribution division can only buy internally. The distribution division, however, can select the quantity to purchase.