Quality improvement and process innovation of a firm facing reference price effects in a dynamic monopoly

In this article, we investigate a monopolist’s efforts for product innovation (or quality improvement) and process innovation (or reducing marginal production cost) with reference price effects in a dynamic setting. The significant features of our work are: (i) a monopolist deals with customer behavior according to economic principles and determines the price of the product, besides, the monopolist carries out the activities of product and process innovation; (ii) the consumers’ demand structure depends on product price, product quality and reference price, and takes a separable multiplicative way between the state variables (product quality and reference price) and the control variables (product price). Our main results suggest that (i) there exists unique saddle-point steady-state equilibrium under monopoly and social planning; (ii) as the memory parameter increases, it is very likely that the monopolist’s steady-state effort for process innovation is greater than that for product innovation; (iii) the efforts for product and process innovation under social planning are greater than that under monopoly; (iv) although the price is still determined by the monopolist under the social planning, the price under the social planning is higher than that under monopoly and (v) there is a negative price-quality relationship.