The dynamics of price, quality and productivity improvement decisions

Although quality has received significant attention during the last decades and its economic benefits are beyond any doubt, lots of questions have remained unanswered as to how much, when, and in what to invest to maintain sustainable competitive advantage. A model is introduced here to guide a firm in addressing these questions. The firm produces a single product and operates in a market where monopolistic competition is effective. Demand for the product in the industry depends on both price and performance quality. Increasing productivity knowledge decreases unit production cost, but demand for the company's product decreases over time, as competitors will be able to offer products with similar performance. Productivity and quality knowledge can be developed through induced and autonomous learning in order to strengthen company position. The paper provides an optimal control formulation of the problem and develops necessary conditions for optimality and characterizes the dynamics of optimal price, quality and investment decisions.