Commitment and price competition in a dynamic differentiated-product duopoly

Abstract

This paper characterizes linear Markov-perfect equilibrium in a duopolistic environment where firms engage in dynamic price competition. Firms have constant (but potentially different) marginal costs and produce differentiated products. We show that, for the case of linear demand, dynamically stable Markov-perfect equilibrium prices are strictly higher than one-shot Nash equilibrium prices, but lower than fully collusive (monopoly) prices. We provide closed-form solutions for the Markov-perfect equilibrium prices which, in principle, can be estimated given data on firm demand and costs. Our results suggest that static two-stage models of price commitment are on reasonably solid ground in that they might be viewed as a “reduced form” for more complicated dynamic models.