Loss Aversion, Price and Quality

The Spence model (1975) is extended so that customers’ utility depends on their disposition to the firm in addition to quantity and quality of the good consumed. Disposition is determined by customers’ perception of firm’s pricing and quality decisions, which perception is ‘reference dependent’. The profit maximising and efficient price and quality combinations are derived. Adjustment to a change in economic conditions may call for price rigidity, quality rigidity or both depending on the level of the reference price and quality