Price leadership in a duopoly with capacity constraints and product differentiation

This paper analyzes Stackelberg price leadership in a duopoly in which firms are capacity constrained and products are imperfect substitutes. Assuming symmetric substitutes, linear demand, and efficient rationing, we characterize the equilibria with an exogenously specified leader. Using the equilibrium profits derived from these games, we argue that over certain ranges of asymmetric capacities an endogenous price leader will emerge. When endogenous leadership does arise, it is the large capacity firm which is the leader. We thus provide a game theoretic model of dominant firm price leadership.