We consider a supply chain with a single supplier and two retailers. The retailers choose their orders strategically, and if their orders exceed the supplier\u27s capacity, quantities are allocated proportionally to the orders. We experimentally study the capacity allocation game using subjects motivated by financial incentives. We find that the Nash equilibrium, which assumes that players are perfectly rational, substantially exaggerates retailers\u27 tendency to strategically order more than they need. We propose a model of bounded rationality based on the quantal response equilibrium, in which players are not perfect optimizers and they face uncertainty in their opponents\u27 actions. We structurally estimate model parameters using the maximum-likelihood method. Our results confirm that retailers exhibit bounded rationality, become more rational through repeated game play, but may not converge to perfect rationality as assumed by the Nash equilibrium. Finally, we consider several alternative behavioral theories and show that they do not explain our experimental data as well as our bounded rationality model
