Abstract: The supply chain considered in this paper is composed of a supplier and a manufacturer. The manufacturer can use a price-dependent penalty policy to the supplier if the supplier provides non-qualified products. Thus, in the supply chain the manufacturer acts as leader. In considering internal quality loss (IOL) and external quality loss (EQL) caused by defective raw materials, a Stackelberg game model is developed for this problem by using the leader-follower game approach. Based on the model, given the expected revenue function of supply chain stakeholders, the sub-game perfect Nash equilibrium is obtained. To evaluate the performance of the proposed approach, numerical examples are presented to test the penalty strategies applied to the four frequently incurred situations. The results indicate that the price-dependent quality penalty strategy can

Key words: supply chain, price-dependent quality penalty, leader-follower game, Nash equilibrium