Consumer Feelings and Equilibrium Product Quality

This paper considers the possibility that a firm can invest not only in the true product quality, but also in activities such as merchandising and store atmosphere that create affect influencing consumer perception of the product quality. Consumers base their purchase decisions on the signal of quality they experience, where the signal is affected by both the true product quality valued by the consumer and the affect the consumer experiences at the time of the signal formation. In this situation, a firm finds it optimal to invest in both product quality and affect inducement, even though rational consumers, in equilibrium, correctly solve back for the true product quality. We uncover an asymmetry in the effects of the cost of producing quality and the cost of affect. As a firm’s cost of quality decreases, the firm will find it optimal to invest more both in the true quality and in the affect inducement, even if it does not have a lower cost of inducing affect. Conversely, if a firm’s cost of affect decreases, then the product quality decreases but affect increases. Under competition, we find that the firm investing more in quality also invests more in affect. An implication of this is that in a competitive environment, consumers can rationally associate an up-lifting store atmosphere, affect-inducing merchandising, or mood-creating communication with high quality products even when signaling motives are absent and when there is no consumption externality of the affect. We also analyze the case in which firms might have different costs and consumers are uncertain about the costs incurred by a given firm. Here again we show that the perceived quality production is positively correlated with both the true quality and the affect production. 1