A dynamic analysis of a monopolist's quality improvement, process innovation and goodwill

Although there are many literatures on firms' product and process innovation in recent years, the effects of advertising-based goodwill and consumers' reference quality on firms' product and process innovation are rarely considered. Therefore, the significant features of our study are: (i) introducing the concept and definition of the consumers' reference quality; (ii) considering the effect of product quality on goodwill; (iii) the customers' demand function depends on product quality, product price, advertising-based goodwill and the difference between product quality and reference quality, and the demand function takes a linear form. Our results suggest that (i) the system admits unique saddle-point steady-state equilibrium under the monopolist decision-making and the social planner regulation; (ii) with the increases of the product quality and goodwill, the corresponding investments also increases; however, with the increase of marginal cost and reference quality, the corresponding investment decreases; (iii) the monopolist's investment in one direction boosts the other in the neighborhood of the steady-state investments in product innovation, process innovation and advertising-based goodwill, respectively; and (iv) the monopolist will have an underinvestment problem as compared with the social planner.