MIDDLE EAST TECHNICAL UNIVERSITY

Ankara, Turkey

INSTITUTE OF APPLIED MATHEMATICS

http://iam.metu.edu.tr

A value-adding approach to reliability

under preventive maintenance costs and its
applications
Sadia Samar Ali1 , Erdem Kilic2 , Gerhard Wilhelm Weber3 , Rameshwar Dubey4
Abstract. No equipment (system) can be perfectly reliable in spite of the utmost care
and best efforts on the part of the designer, decision maker and manufacturer. For a large
number of systems, maintenance is a must, as it is one of the effective ways of increasing
the reliability of the system. The two sides of maintenance are corrective and preventive
maintenance. It is generally assumed that a preventive maintenance action is less costly
than a repair maintenance action. Folk wisdom supports the notion that a higher quality
translates into lower maintenance costs (as well as other components of life-cycle costs)
for the users. We examine this proposition in detail on the basis of a failure-time model that
relates conformance quality to reliability. We know that maintenance plays an important
role in reliability theory and it increases the life-time of an item or system at lower cost.
Illustratively, we present reliability in the context of contracts with asymmetric information. The model show how to overcome information rents through price distortions and
quantity rationing. In this paper, we have shown how preventive maintenance is affecting
on different life-time distributions. The paper ends with a conclusion and an outlook to
future studies.

Keywords. Reliability function under preventive maintenance, Probability distribution, Financial means, Operational Research, Manufacturing Services, Economics

Preprint No. 2013-04-19

April 2013

1 Fortune Institute of International Business, New Delhi 110057 India, +91-9650691133, email:
sadiasamarali@gmail.com
2 Faculty of Business Administration and Economics, Yeditepe University, Turkey, email:
rdmklc@gmail.com
3 Institute of Applied Mathematics, Middle East Technical University, Turkey
4 Symbiosis Institute of Operations Management, Nashik, India

Figure 1. Representation of Reliability in a System.

Introduction

It is supposed to be a fact that no system or a equipment is perfect in the sense that

it will continue to function (without failure) forever, how so ever carefully it might
have been designed and manufactured. However, it is assumed that the reliability
of equipment or a system may be increased by proper maintenance. Such
maintenance is known as preventive maintenance. It is done periodically, before
the failure of the system; hence, it is different from the corrective or repair
maintenance, which is carried out only after the failure of the item or the system
[5, 19].
In this paper, we examine the effect of preventive maintenance on the reliability of
an item that functions until the first failure, which comes under support of Reliability, Maintainability, Supportability, Quality (RMSQ) as shown in Figure 1. This
figure depicts a cycle of different phases of products including RMSQ. For this
purpose we consider some well-known life-time distributions in this relation.
In Section 2, we consider the effect of preventive maintenance on the reliability
of an item that follows an exponential failure time distribution. It is shown that
preventive maintenance does not improve the reliability of such an item. We prove
that the mean time to failure (MTTF) of such an item is equal to the mean life-time
without maintenance and we establish it as a characteristics property of exponential
failure time distribution. In Section 3, we consider a power function distribution
and obtain the condition under which maintenance reliability exceeds the reliability
without maintenance. In Section 4, we discuss the effect of preventive maintenance
with respect to some other distributions with a general discussion on preventive
maintenance. Two types of relative maintenance policies had been considered by
Barlow and Hunter [4]; Crow [15]; Abdel-Hameed [1]; Tjiparuro and Thompson
[30].
Birolini [6] and Khan Malik [23] discussed reliability models which were built
for a service producing system which works intermittently, is subject to wear, and
2

can be improved through maintenance actions like leaning, lubrication, and realignment, etc., short replacement. Juang and Gary [21] considered a theoretic
Bayesian approach to determine an optimal adaptive preventive maintenance policy with minimal repair. When the failure density is Weibull with uncertain parameters, a Bayesian approach is established to formally express and update the
uncertain parameters for determining an optimal adaptive preventive maintenance
policy. Chelbi and Ait-Kadi [12] considered a repairable production unit subject
to random failures, which supplies input to a subsequent assembly line, operating
according to a just-in-time configuration. Preventive maintenance actions are regularly performed on the production unit at instants T, 2T, 3T, . . . . The corrective
and preventive maintenance actions have random durations.
Lifeng et al. [26] tries to integrate a sequential imperfect maintenance policy into
condition-based predictive maintenance (CBPM). A reliability-centered predictive
maintenance policy is proposed for a continuously monitored system subject to
degradation due to the imperfect maintenance. It is assumed that the system hazard
rate is a known function of the system condition and then can be derived directly
through CBPM.
Currit and Singpurwalla [17] explored the reliability function of a system of components sharing a common environment. Kolowrocki [24] has a given concept for
reliability function of a homogenous series such as parallel-parallel and parallelseries system. Barlow and Hunter [4] worked on optimum preventive maintenance
polices and Juang and Gary [21] used Bayesian method on adoptive preventive
maintenance problem.
Bloch-Mercier [10] analysed sequential checking procedure for checking procedure of markov deteriorating system. Kong and Frangopol [25]; Vassiliadis and
Pislikopoulos [31] used maintenance scheduling and process optimization under in
environment of uncertainty. Blanchard et al. [9], Blanchard and Fabrycky [8] and
Abdel-Hameed [1] focus many concepts on maintainability and their applications
for effective serviceability and maintenance. Clroux et al. [14] explored the age
replacement problem with minimal repair costs. The techniques of optimal number
of minimal repairs before replacement discussed by Park [27]. Many models have
been analysed for product quality with warranty cost by Chen [13]. Kackar [22] explored Taguchis quality philosophy, analysed with different cases and commented
on each cases. The problem of strength-reliability of the equipment defined as the
probability that the strength of equipment exceeds the stress, instead of finding
P(X > Y ) for a given set of distribution and found the required parametric values
of the assumed distributions to achieve a desired level of strength reliability. Samar
Ali and Kannan [29] and Alam and Roohi [2] assumed exponential strength and
exponential stress for this purpose. Alternatives for augmenting the exponential
strength-reliability have been suggested against the exponential distributed stress.
As an illustrative example we discuss the relevance of reliability in the context
of a manufacturer and dealer contracting model with asymmetric information related to the proposed model by Blair and Lewis [7] in the Sections 5 and 6. The
3

dealer is providing maintenance services which increase the reliability in his economic transactions. He has full-information about the maintenance services and
the related maintenance costs. On contrary, the dealer does not have exact knowledge about the final realization of the maintenance costs. The remainder of the
article is organized as follows. Section 2 analyzes the reliability for exponential
distribution under preventive maintenance. Section 3 introduces the reliability for
the power function distribution under preventive maintenance. Then, Section 4
presents reliability under preventive maintenance for other life-time distributions.
Section 5 introduces a model for optimal retail contracts under asymmetric information. Whereas, Section 6 presents the illustration about dynamics of optimal
contracts. Finally, Section 7 concludes and gives an outlook to future studies.

Reliability for exponential distribution under preventive maintenance

It is well-known that exponential distribution has constant failure rate and this is
the characteristics property of it. Now we consider the case of reliability under
preventive maintenance of equipment following exponential distribution [20]; [16];
[18]; [11]. If the probability density function (pdf) of failure time T is given by
f (t) = et

(t > 0) ,

(1)

then reliability of such an equipment is introduced assumed as

R (t) = et

(t > 0) .

(2)

When we use the result, maintenance reliability is defined as

Rn (t) = (R (T ))n R(t nT )

(nT t (n + 1)T ) .

Here, R(t) and Rn (t) be the reliability of a system without maintenance and with
maintenance respectively (n N0 ).
We find reliability of that equipment with regular preventive maintenance at time
T, 2T, 3T, ..., is given by

RN (t) =

e T

n

e (tnT )

for nT t (n + 1) T.

We note that this definition does not depend on the number of preventive maintenance. Therefore, we conclude that preventive maintenance does not improve the
reliability of equipment having an exponential failure distribution. We present and
prove a main important result stated in the form of a theorem.

Theorem 2.1 Preventive maintenance does not improve the reliability of an equipment or system if it has a constant failure rate.
Proof Let us suppose that the reliability does not improve after preventive maintenance or mean time to failure (MTTF) is constant with respect to maintenance
after any regarded time T , i.e.,
T
MTTF =

R (t) dt
=
1 R (T )
0

or

R (t) dt = (1 R ( T )) .
0

Differentiating both the sides with respect to T , we get

R (T ) = R0 (T ) ,
thus,
R0 (T ) / R (T ) =
i.e.,
ln (R (T )) =

1
,

T
+ c.

Therefore,
R ( T ) = e(T /) + c

T 0,

where c is constant of integration. However, R (0) = 1, therefore, c = 0. Thus,

R (T ) = eT / ,
which is the reliability at time T , of an item following an exponential distribution. Hence, it shows that equipment with constant MTTF follows an exponential
distribution.
Now we consider that equipment follows exponential distribution and has the reliability R (T ) = et / . Hence, the MTTF with respect to maintenance after time T
is given by
T

n
o n
o
et /
T /
T /
=

e
/
1

e
=,
1 eT /
This proves the theorem. 
MTTF =

Reliability for the power function distribution under preventive maintenance

The reliability function for the power function distribution is given by

R (t) =

ka t a
(0 t k) ,
ka

Reliability of such an item under preventive maintenance, is given by

 a
 a

k ta
k (t nT )a
n
RM (t) = (R (t) ) [R (t nT )] =
(nT t (n + 1) T ) ,
ka
ka
for n {0, 1, ..., M 1} , where M N. In order that the reliability under preventive maintenance be more than that of without maintenance, we must have
{RM (t) /R (t)} > 1 at the time of preventive maintenance t = nT, where n = 1, 2, 3..., M,
i.e.,
"
#
a
n
1 Tka
RM ( nT )
=
> 1.
a
R(t)
1 (nTa)
k

Hence,

 a  a
nT a
nT
nT
nT a
=
a > 0;
1 a > 1
k
k
k
k

thus,
na n > 0 ,
a > 1.
This means that preventive maintenance will improve the reliability of the power
function system, if a 1. It simply means that for a < 1, preventive maintenance
may not be useful. To get a better insight into this result, Tables 2.1-2.4 present
RM (t), the reliability with maintenance for selected values of a. Without loss of
generality, we assume k =1, doing a normalization otherwise.
Table 2.1. R (t) and RM (t); T=0.25, a=0.5.
t
0.1
0.25
0.3
0.4
R (t)
0.6838 0.5000 0.4523 0.3675
RM (t)
0.6838 0.5000 0.3882 0.3064
Table 2.2. R (t) and RM (t); T=0.25, a=1.
t
0.1 0.2 0.25 0.3
0.4
R (t)
0.9 0.8 0.75 0.7
0.6
RM (t)
0.9 0.8 0.75 0.7125 0.6375

0.5
0.2929
0.2500

0.5
0.5
0.5635

0.6
0.2254
0.1709

0.6
0.4
0.5063

0.75
0.1339
0.1250

0.8
0.1056
0.0970

0.9
0.0513
0.0766

1
0
0.625

0.75
0.25
0.45

0.8
0.2
0.4008

0.9
0.1
0.3586

1
0
0.3164

Table 2.3. R (t) and RM (t); T=0.25, a=2.

t
0.1
0.25
0.3
0.4
R (t)
0.99 0.91
0.84
0.75
RM (t)
0.99 0.9375 0.9352 0.9164
Table 2.4. R (t) and RM (t); T=0.25, a=3.
t
0.1
0.25
0.3
0.4
R (t)
0.999
0.984
0.973
0.936
RM (t)
0.999
0.9844 0.9842 0.9811

0.5
0.64
0.8789

0.5
0.875
0.9689

0.6
0.51
0.8701

0.6
0.784
0.9680

0.75
0.44
0.8438

0.75
0.578
0.9612

0.8
0.36
0.8219

0.8
0.488
0.9537

Reliability under preventive maintenance for other lifetime distributions

In this section we derive the expression for the maintenance reliability for different
life-time-distributions.

4.1 Weibull distribution

The probability density function (pdf) of Weibull distribution is given by
   
 t  1
t
f (t ) =
exp
(t 0),

where , > 0. The reliability function for this distribution is given by

   
t
.
R (t) = exp

Reliability under preventive maintenance of such an equipment or system is defined

by
" 
"

 #n
 #
T
t nT
RM (t) = exp
exp
.

In order
 to see the effect of preventive maintenance, we have to find the values
RM (t) R (t) at the time of preventive maintenance t = nT :
h

i
T
exp
n

RM (nT )
h
=

i > 1 > 1.
R (nT )
exp nT

This means that the preventive method is effective for the Weibull system, if for
the shape parameter it holds > 1.

0.9
0.19
0.8054

0.9
0.271
0.9506

1
0
0.7724

1
0
0.9389

4.2 Normal distribution

The probability density function of normal distribution is given by
"

 #
1 t 2
1
f (t) = exp
(t 0) ,
2

2
where , > 0. There is no closed-form solution for the normal reliability function. Solutions can be obtained via the use of standard normal tables. Thus,


t
R (t) = 1
.
T
Reliability under preventive maintenance is represented by


 


T n
t nT
1
.
RM (t) = 1
T
T

4.3 Gamma distribution

The probability density function of the Gamma distribution is given by
f (t) =

t 1
()

(t 0) ,

where 0.
Here, is the shape parameter, and is the Gamma function given by the relation

(a) =
t a1 e1 dt.
0

There is no closed form of reliability function for the Gamma distribution also.
Thus, the reliability function is given by
R (t ) = 1

t ()
()

(t 0),

with some > 0. Here, t (a) is an incomplete Gamma function defined by relation
t
t a1 et dt.

t (a) =
0

We can obtain the solutions using the table of incomplete Gamma Distribution
introduced by Pearson [28].
Reliability under preventive maintenance for Gamma distribution is defined as

 


T () n
t+nT ()
RM (t) = 1
1
()
()

(t 0) .

No general comment is possible on the behaviour of the reliability under preventive

maintenance for Normal and Gamma distribution.

Optimal retail contract under asymmetric information

This section gives an illustrative operative example for optimal contracts with incorporation of maintenance costs under asymmetric information. We analyze the
effect of asymmetric information on the price and the quantity of a sale product,
resulting from the agent problem evolving between the retailer and the manufacturer, when incorporating the (optimal) maintenance costs or reliability in a broader
sense. The manufacturer produces a sale product at constant unit costs. The retailer
or manufacturer sells the product on the market while he provides promotion and
additional customer services, such as maintenance of a product and consumer education. We focus on a single retailer within a monopoly framework to exclude the
agent problem from externalities.
The manufacturer determines the price of the product but he is not informed about
the exact market demand. The retailer has knowledge about the market demand
and the promotional services. The quantity of the sale product is derived by the
market demand. The retailer or dealer takes in account the repair costs prior to his
sale; he anticipates to replace the repair costs with the maintenance costs. Given
this consideration the determination of the optimal contract under asymmetric information plays a key role. The likelihood of an optimal contract is described in the
cases when maintenance costs evolve according to the certain dynamics. As main
factors we can mention the life-time utility of a product and the negotiated price in
the contract. So, the contract evolves according to dynamics of maintenance costs,
the probable life-time distribution of the product and the products price effects.
The optimal quantity is a consequence resulting from the mentioned dynamics.

5.1 Market demand and reliability

Market demand is determined as Q(p, X, Rt ), p being the retail price, X denoting
the total expenditure on promotion, while the reliability Rt is determined by maintenance costs. The promotion function is provided as X(p, Q, Rt ).
Given our assumptions on demand, we have Xp , XQ > 0 and XR < 0, which means
that promotion is increasing in price and sales, and decreasing in Rt . Here, the
dealer has perfect knowledge about Rt , and the dealer has imperfect knowledge
about Rt . Hence, for the manufacturer Rt follows a density function, because the
reliability is the realization of a random variable:

d (1 F(Rt ))
0.
dRt
f (Rt )

(3)

The joint profit for the manufacturer and the dealer is defined as follows J (Q, p) =
pQ X (p, Q, Rt ), where the function is strictly concave in p and Q:
2 J
> 0.
Q p

(MC)

The promotional services provided by the dealer include customer services, such
as maintenance costs, free delivery, installation and repair services. The degree of
maintenance can be presumed as reliability. The endogenous reliability is defined
by R (t) = et (t > 0). It states the dynamic under which the maintenance improves the reliability of a manufacturing system or of an equipment.
The dealer reports the manufacturer his maintenance services which we denote
here as reliability Rt . The dealer pays a fee A to the manufacturer which is the
franchise fee. The dealer has the right to offer a contract that the manu-facturer
either accepts or rejects. The additional profit comes from the information rent
that the dealer obtains from the knowledge about Rt which is not observable by the
manufacturer.
Then, the optimization process evolves according to the market demand and supply functions and the preferences of the dealer. The dealer has the incentive to
have a good measure of reliability, so he tries various reliability distributions as
benchmarks for the density function of R. His maximization problem is described
as


0
0
0
0
d (Rt |Rt ) = max 0 p(Rt )Q X p(Rt ), Q, Rt A(Rt ) .
(4)
QQ(Rt )

Here, R0 denotes alternative reliability distributions. The optimal retail contract

will depend on how the manufacturers choice of p and Q affects this marginal rate
of substitution. We assume that the following cases have to be distinguished in this
relation:
XpR , XQR > 0 ,

(P1)

XpR , XQR < 0 ,

(P2)

XpR , XQR = 0 .

(P3)

In cases (P1) and (P2), the marginal rate of substitution depends on both price and
quantity level.
10

5.2 Manufacturers problem

The design of a contract with a decision consisting of a strategy {p(Rt ), Q(Rt ), A(Rt )}
is given as the following optimization problem:

RH

A(Rt )dR ,

maximize
RL

subject to

d (Rt |Rt ) 0 ,

(IR)

d (Rt ) = d (Rt |Rt ) d (Rt |Rt ) ,

(IC)

Q(Rt ) argmax [p(Rt )Q X (p(Rt ), Q, Rt ) A(Rt )] .

(SC)

The necessary and sufficient conditions for implementing retail incentive contracts
are represented by (SC).
The individual rationality (IR) condition stipulates that the dealer must earn at least
his reservation profit. (IC) is an incentive compatibility constraint, which implies
that the dealer maximizes her profits when he truthfully reports Rt in accord with
the revelation principle. The sales constraints (SC) indicates that the dealer cannot
be induced to sell more than the profit-maximizing level.
Lemma 1. Necessary and sufficient conditions for implementing retail incentive
contracts are SC and

RH

(i) (Rt ) =

(X ) d Rt ,

(ii) Q (Rt ), p0 (Rt ) 0

0

(iii) Q (Rt ), p0 (Rt ) 0

Using Lemma 1, the transfer fee can be written as:

11

for case

(P1),

for case

(P2).

A(Rt ) = p(Rt )Q(Rt ) X (p(Rt ), Q(Rt ), Rt )

RH
R

(XR )d Rt .

The finalized manufacturers problem then becomes

RH

[p(Rt )Q(Rt ) X (p(Rt ), Q(Rt ), Rt ) + h(Rt )XRt ] dF(Rt ) ,

maximize
p(Rt ), Q(Rt )

subject to (SC),
where h(Rt ) = (1 F(Rt ))/ f (Rt ).

Dynamics of optimal contracts

6.1 Optimality dynamics

The first best contract is described in Lemma 2. The optimal decision is given as
{p (Rt ), Q (Rt ), A (Rt )} when the manufacturer can observe the degree of reliability.
Lemma 2. In the first-best contract:
(i) p (Rt ) = XQ ,
(ii) Q (Rt ) = Xp ,
(iii) d (Rt ) = 0.
The conditions (i)-(ii) describe that price and quantity are equal to the marginal
cost. Condition (iii) states that dealer is not allowed to have excess profit at all
through the intervention of the manufacturer. A franchise fee, which is set by the
manufacturer, transfers the revenues from the dealer to the manufacturer without
modifying the price or the quantity. With full-information the manufacturer would
choose the first best solutions p(Rt ) and Q(Rt ) to maximize the profit. This
would mean that the manufacturer could avoid potential distortions in the choice
of the price and quantity.
The optimal contract is characterized according to the cases for (P1) through (P2).
Various outcomes for the different cases are described in the next section. The
manufacturer introduces price and quantity distortions.
It is optimal to introduce price and quantity distortions into the retail contract for
cases (P1) and (P2). The following propositions describe the nature of these distortions. Denote pJ (Q(Rt ), Rt ) as the joint-profit-maximizing price given Q(Rt ) and
Rt , and QJ (p(Rt ), Rt ) as the joint-profit-maximizing quantity given p(Rt ) and Rt .
12

(M)

Proposition 1. Given condition (P1) (XpRt , XQRt > 0), the solution to (M)0
involves
(i) price ceilings with p(Rt ) pJ (Q(Rt ), Rt ) p (Rt )
(ii) quantity rationing with Q(Rt ) QJ (p(Rt ), Rt ) Q (Rt )

for
for

Rt < RH,t ,
Rt < RH,t .

6.2 Optimal pricing and output distortions

The dealer has the opportunity to derive an information rent because of his insider information. The information rent that the dealer commands, depends on the
marginal rate of substitution of exogenous demand (X) for reliability. This interdependence is increasing in both p and Q. The optimal pricing and output distortions
determine the substitutionality between X and Rt . This substitutionality induces
decreasing information rents of the dealer.
The manufacturer profits are higher with a price ceiling and information rents are
declining with a decrease in quantity. This means that it is optimal for the manufacturer to force the dealer to sell below the joint-profit-maximizing quantity.
In (P2) the substitutability between X and Rt is decreased when the price p and the
quantity Q are increased. To reduce the information rents the manufacturer aims to
set the price p and quantity Q higher than the profit maximizing level. However,
he cannot force the dealer to sell more. The mechanism is resulting in a price floor
which allows the dealer to choose the profit-maximizing quantity for the predetermined price.
Proposition 2. Given condition (P2) (XpRt , XQRt < 0) the solution to (M)0 involves
(i) price floors with p(Rt ) pJ (Q(Rt ), Rt ) p (Rt )
(ii) quantity rationing with Q(Rt ) = QJ (p(Rt ), Rt ) Q (Rt )

for
for

Rt < RH,t ,
Rt < RH,t .

Conclusion and Outlook

We know that maintenance plays an important role in reliability theory and it increases the life-time of an item or system at lower cost. In the above discussion,
the preventive maintenance effect on different time distributions has been investigated. In this paper, we have shown that preventive maintenance affects different
life-time distributions. The preventive method is effective for the Weibull system,
if for the shape parameter it holds > 1 and for Normal distribution, while for
Gamma distribution no general comments are possible.

13

We present an example where reliability in the form of maintenance costs is subject to asymmetric information. Price, quantity and market demand relationship
are incorporated in a dynamic framework which analyzes the maintenance costs as
a policy variable. The outcome is determined according to quantity rationing and
price policies.
As a further setting of the model, different markets can be chosen by analyzing the
different price setting strategies and consumer behavior in relation to maintenance
costs or to reliability in general. In addition, applications of stochastic differential
equations or stochastic hybrid systems can be considered to obtain more insight
information about the model dynamics.

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Appendix
Proof of Lemma 1
A necessary condition for local incentive compatibility is
d, (Rt ) = 2d (Rt |Rt ) = XRt > 0 .

(A1)

In fact, d (Rt ) is decreasing, individual rationality binds only at Rt = RH,t . Thus,

(A1) implies
RH
(Rt ) = 0 + (XRt )d Rt .
d

16

(A2)

The first-order condition for local incentive compatibility implies that

1d (Rt |Rt ) = 0 ;

(A3)

the second-order conditions for local incentive compatibility require

d
11
(Rt |Rt ) 0 .

(A4)

Total differentiation of (A3) with respect to Rt and employing (A4) implies that the
following is required:
d
d
d
0 11
= 12
= 21
= XRt ,p p0 (Rt ) + XRt Q Q0 (Rt ) .

(A5)

In case of (P1) or (P2), it follows that Q0 , p0 0 (Q0 , p0 0), respectively are

sufficient to satisfy (A5). The proof is completed by showing that local incentive
compatibility implies global incentive compatibility .
Proof of Lemma 2
The first-best problem is written as max = p(Rt )Q(Rt ) X(Rt ). Optimization
p,Q

yields p = Q (Rt ) Xp (Rt ) = 0 and Q = p (Rt ) XQ (Rt ) = 0. In the first-best

case, the upstream firm only needs to provide the downstream firm with its reservation profit level; i.e., d = 0. 
According to conditions (i) and (ii), price and quantity are chosen so that the
marginal revenue equals the marginal cost. Marginal cost is measured by the increase in promotion required when either price or quantity is increased. Condition
(iii) implies that the manufacturer extracts all excess profits from the dealer.
Proof of Propostion 1
Assume (SC) is not binding in the solution to (M)0 . Differentiation of (M)0 with
respect to Q and p yields pm = Q(Rt ) Xp + h(Rt )XRt ,p = 0 and Qm = p(Rt )
XQ + h(Rt )XRt ,p = 0, implying that pJ (p(Rt ), Q(Rt ), Rt ) = h(Rt )XRt ,p > 0 and
QJ (p(Rt ), Q(Rt ), Rt ) = h(Rt )XRt p > 0 where J is defined in the text.
0
Given (MC) and strictly concavity of J (p, Q, Rt ), this implies pJ (Rt )(Q (Rt ), Rt )
and QJ (p(Rt ), Rt ) are increasing functions.
Let p1 (Q(Rt ), Rt ) be the inverse of QJ (p(Rt ), Rt ). Strict concavity of J implies
0
0
that pJ (Q (Rt ), Rt ) intersects p1 (Q (Rt ), Rt ) once at Q . It is now easy to verify
that
>

pJ (Q(Rt ), Rt ) = p1 (Q(Rt ), Rt ) as Q = Q .
<

(A6)

For case (P1), pJ , QJ > 0. Given the strict concavity of J and (A6), this implies that p(Rt ) < pJ (Q(Rt ), Rt ) and (p(Rt ), (Q(Rt )) lies at a point between the
pJ (Rt , Q(Rt )) and p1 (Rt , Q(Rt )) schedules. Hence, for case (P1), Q(Rt ) < Q and
17

p(Rt ) < p . To complete our proof, notice that Q(Rt ) < QJ (p(Rt ), Rt ) which verifies that (SC) is nonbinding as we originally asserted. 
Proof of Propostion 2
For case (P2), (SC) is binding by following argument. Suppose that (SC) is not
binding, then QJ > 0 and pJ < 0, implying that (p(Rt ), Q(Rt )) must be located
at a point Q > Q , between the p1 (Rt , Q(Rt )) and the pJ (Rt , Q(Rt )) schedules.
However, in the proof of Proposition 1, we demonstrated that (p(Rt ), Q(Rt )) must
be located at a point Q < Q , between the pJ (Rt , Q(Rt )) and the p1 (Rt , Q(Rt ))
schedules whenever (SC) is not binding. Thus, Q(Rt ) = QJ (p(Rt ), Rt ), since the
value of Q that maximizes the dealer profits also maximizes joint profits given
the price p(Rt ). In this instance, the manufacturer chooses the following price,
recognizing that it will influence the quantity; QJ (p(Rt ), Rt ), which the dealer sells.
The first-order condition for the choice of p(Rt ) is given by
d m
= pJ + QJ [dQJ /d p] + h(Rt )[XRt ,p + XRt Q [dQJ /d p] ,
dp

(A7)

pJ = h(Rt )XRt ,p h(Rt )XRt ,Q [dQJ /d p] = 0 ,

where, the second lime follows from the fact that QJ = 0 for QJ (p(Rt ), Rt ). Solving
(A7) for pJ yields
pJ = h(Rt )XRt , p h(Rt )XRt ,Q [dQJ /d p] < 0 ,
J /
J
because [dQJ /d p] = pQ
QQ by (MC). Consequently, we have p(Rt ) > p (Q(Rt ), Rt )
and Q(Rt ) = QJ (p(Rt ), Rt ). This implies that (p(Rt ), Q(Rt )) lies on the p1 (Rt , Q(Rt ))
schedule, where Q(Rt ) > Q and p(Rt ) > p . 

18