Process Improvement, Quality, and Learning Effects

While quality has attracted significant attention in the past two decades, the debate is still on as to whether a firm should aim for zero defects or base its quality decisions on cost-benefit trade-offs. The continuous improvement advocates generally eschew the cost trade-off approach, but U.S. firms, after spending substantial sums on quality-related activities in the 1980s, appear to be focusing again on cost trade-offs and measures such as return on quality. This paper provides analytical support for the continuous improvement argument while relying on a cost trade-off analysis. We present a dynamic model of a monopolist making decisions on price, production, process improvement, and quality assurance efforts. The model is comprehensive and captures the effects of autonomous and induced learning on both productivity and quality and incorporates quality related costs in detail. Using this model, we show that quality improves over time, while process improvement effort and quality assurance effort decrease over time. In fact, as anecdotal and empirical evidence suggests, process improvement and quality assurance effort is high when quality level is low, and vice-versa. The optimal production rate is increasing and the optimal price is decreasing over time. We also provide valuable insights into the impact of changes in key parameters such as interest rates on production, price, process improvement effort, and quality assurance effort.