Fraction of Revenues for Advertising: Finding the Perfect Balance

What fraction of revenues should the firm spend on advertising if the estimates for the price elasticity of demand is -9.6 and the advertising elasticity of demand is 1.6?

30%

64%

16.6%

25%

Answer:

The fraction of revenues that the firm should spend on advertising is 16.6%.

In the world of business, finding the right balance in advertising expenditure is crucial for success. To determine the fraction of revenues that a firm should allocate to advertising, we need to consider the estimates for both the price elasticity of demand and the advertising elasticity of demand.

The formula to calculate the advertising-to-revenue ratio is: Advertising-to-revenue ratio = (Advertising elasticity / Price elasticity) * (1 - (1 / Price elasticity)).

Given: Price elasticity of demand = -9.6 Advertising elasticity of demand = 1.6

Plugging in the values into the formula, we get: Advertising-to-revenue ratio = (1.6 / -9.6) * (1 - (1 / -9.6)) Advertising-to-revenue ratio ≈ -0.166

Since the result is a negative value due to the opposite signs of price elasticity of demand and advertising elasticity of demand, we take the absolute value to get a positive fraction: Advertising-to-revenue ratio ≈ 0.166

Converting this ratio to a percentage, we find that the firm should spend approximately 16.6% of its revenues on advertising. This balanced approach ensures optimal utilization of resources while maximizing the impact of advertising efforts.

Remember, effective advertising is not just about spending big but spending smart. By understanding the key factors influencing advertising expenditure, businesses can make informed decisions to drive growth and success.