I disagree. There are lots of people who will happily pay $10 more for JetBlue, because they know that they'll get a decent seat with its own TV. JetBlue has made an effort to differentiate themselves in this way from most other airlines, many customers know that, and are willing to pay a little extra for it.
The problem other carriers have with this IMO is not that it's not possible. It's that they haven't really made a sustained commitment to differentiate themselves on service. It takes time: they have to do things better for long enough for people to notice.
But the idea that folks won't pay more for better service is wrong in general. How many infrequent fliers have you met who "won't fly XX airline" because of some bad experience, or who "like YY airline." for whatever reason?
Of course this isn't true for everyone, and different people value different things. I, for example, will never pay more for a better hotel room -- I'll book the cheapest place that has a bed and a shower. But it's true for many.
If it is true that "There are lots of people who will happily pay $10 more for JetBlue", then why do they price themselves below the legacy carriers? It ain't benevolence and it ain't because they don't want to appear to be making excess profit.
I happen to agree with you that people will pay more for better service, there is no question about it. But an airline seat in coach for the once or twice a year, few hour trip to grandma's is not considered a service product, it is a commodity that the internet allows them to acquire based on the three most important factors in the purchase of an airline seat, price, price and price. Even the business traveller is very often restricted by the financial department to travelling on the lowest price or the airline with which they have negotiated the biggest discount. The business seat, or first class seat is a completely different story and here the service factor among the small sector of the populace purchasing these seats is unquestionably a major factor in the purchase decision.
I won't pay more for a "better" hotel room, but I will pay more for a Hilton than a TravelLodge. I have stayed at a Four Seasons hotel only once, at a business conference - to me this is an example of a "better" hotel room. The TravelLodge and other low end hotels reputation and often sections of town are an example of a product I will not buy. In the Sheraton, Hilton and Marriott families, the product is a commodity to me and then the sole reason to buy, assuming comparable location, is based on the three most important factors, which you probably have guessed are price, price and price.