Dan Arielly did a couple of interesting experiments on this. He had people paying for products in a cashier line (i.e. people who had their wallet out anyway) choose between two really good offers: Hershey chocolate for $0.10 and Lind chocolate for $0.20 (or something like that, I forgot the detailed numbers, it may have been $1/$2 or $0.5/$1). In that case, most people choose the more expensive Lind chocolate as it was clearly the superior product (i.e. higher quality). When he repeated the experiment with $0.10 for the Lind and $0.0 (i.e. Free) for the Hershey's, the game changed. Everybody took the Hersheys. Even though the pricing didn't really change, they only both became cheaper, by the same amount.
The verdict, really, is that if there's something free around, we go nuts and quality doesn't matter much anymore, because it is free. If free apps, on the app store, would be at least $0.50, or even $0.10, I think it would totally change the game. (I.e. if Apple would change the Free Tier).
But as it is right now, I think the downward spiral will continue. The only way out is to create a high quality superior product (many features, etc) with a high price tag and hope that you get enough customers to survive. That also should lead to less support load.