Optimal Capacity Expansion Policy with a Deductible Reservation Contract

Abstract

This paper investigates an optimal capacity expansion policy for innovative product in a context of one supplier and one retailer. With a fully deductible contract, we employ the Stackelberg game model to examine the negotiation process of capacity expansion in a single period. We first derive the retailer's optimal reservation strategy and then characterize the optimal capacity expansion policy for the supplier. We also investigate the impacts of reservation price on the optimal strategy of capacity reservation and expansion as well as the supplier’s expected profits.