Commitment and price competition in a dynamic differentiated-product duopoly

This paper characterizes linear Markov-perfect equilibrium in a duopolistic environment where firms engage in dynamic price competition. Firms have co nstant (but potentially different) marginal costs and produce differentiate d products. We show that? for the case of linear demand, dynamically stable Markov-perfect equilibrium prices are strictly higher than one-shot Nash e quilibrium prices, but lower than fully collusive (monopoly) prices. We pro vide closed-form solutions for the Markov-perfect equilibrium prices which, in principle, can be estimated given data on firm demand and costs. Our re sults suggest that static two-stage models of price commitment are on reaso nably solid ground in that they might be viewed as a "reduced form" for mor e complicated dynamic models.