Abstract:
This article examines the dynamic relationship between a firm’s decision to vary the quality of a product,
consumer response to this variation, and the effect this could have on the firm’s profit and value. This is achieved
through the construction and analysis of a discrete-time optimal control model which incorporates consumer
response. The consumer response model is based on sampling the product’s market prior to the reduction in
quality. The model is then solved numerically. The optimal time to reduce quality is shown to be affected by the
ratio of price and cost differentials associated with differences in quality, and the shareholders’ required rate of
return.
