I suppose it's possible for a teacher to demoraliaze a student by playing for them. But, I would think this is rare. There are abusive teachers, however, I don't think that applies here for this question.
For the most part, it is the students position to be in a state of mind that they are there to learn. It is inappropriately sensitive to take the teachers playing personally. I also have been fortunate to study with teachers who were phenomenal performers; that's why I studied with them. There is nothing they could play, or have any reason that would make me less than thrilled to here them play. Chopin and Beethoven always demonstrated for their students, and not always to make the student feel good. If I were studying with either of them, my attitude would be "Yes, Sir!!". Not, poor me. When I took swimming lessons, I was not to good at it. I felt awful. But, I knew that everyone else had to carry on anyway. Did I resent my teachers demonstration of a perfect dive? Of course not. What would a person so sensitive do in a master class? There, one not only has to listen to everyone play their best, but everyone, including other teachers there, get to critique your playing, going around a circle. Weekly. What do you think all these students do? They cope. It's the only way to survive in a performance oriented occupation such as playing an instrument.
Have you ever played or sung in an ensemble? You will be called out and corrected in front of everyone if you have something wrong. That's just the way it is.
If the student's self esteem is so low that they feel they have a right to compare themselves with the teacher, then they are going to have a rough time of it, and not just in music. Piano playing is performing, and it is not healthy to imagine oneself deserving to be handled with kid gloves. This is simply immature.
I am a teacher, and I play regularly for my students and I play their pieces for them sometimes. Most students smile eagerly when I step around to the bench. Do you think I should stop doing this if a student looks sad or defeateded because of this? No, because it's all part of growing up.
I felt that this needed to be said bluntly because it is dangerous to try to control educators in this way. One day, the student may find themselves in the role of teacher. I would hope they will then see how childish it was to feel slighted by a good performance.
Learn! Be happy that your there! Don't take things so personally. I really find this to be a personality issue more than anything. Smile!