Capacity-constrained Price Competition When Unit Costs Differ

This paper characterizes the set of Nash equilibria in a price setting duopoly in which firms have limited capacity, and in which unit costs of production up to capacity may differ. Assuming concave revenue and efficient rationing, we show that the case of different unit costs involves a tractable generalization of the methods used to analyze the case of identical costs. However, the supports of the two firms' equilibrium price distributions need no longer be connected and need not coincide. In addition, the supports of the equilibrium price distributions need no longer be continuous in the underlying parameters of the model. Two applications of our characterization are pursued. In the Kreps-Scheinkman model of capacity choice followed by Bertrand-Edgeworth price competition we show that, unlike in the case of identical costs, Cournot equilibrium capacity levels need not arise as subgame-perfect equilibria. The low-cost firm has greater incentive to price its rival out of the market than exists under Cournot behavior. Our second application is to the analysis of the effects of tariffs and quotas in a model in which a domestic market is supplied by a price setting duopoly consisting of a domestic and a foreign firm. We obtain a strong nonequivalence result.