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IAI Actuarial Core Principles · Business Economics · Impact of advertising on sales and demand

A life insurer finds that a 10% increase in its advertising spend is followed by a 3% rise in policy sales, other factors unchanged. What is the advertising elasticity of demand (sales), and how should it be described?

The advertising elasticity is 0.3, found by dividing the 3% rise in sales by the 10% rise in advertising. Because it is below one, sales respond less than proportionately to advertising, so demand is advertising-inelastic.

  1. A0.3, advertising-inelastic: sales respond less than proportionatelyCorrect
  2. B3.0, advertising-elastic: sales respond more than proportionately
  3. C0.3, advertising-elastic: sales respond more than proportionately
  4. D3.3, unit elastic
  5. -0.3, because advertising reduces price sensitivity

Explanation

Advertising elasticity = % change in sales / % change in advertising = 3/10 = 0.3. A value below 1 means sales rise less than proportionately, so demand is advertising-inelastic. The option giving 3.0 inverts the ratio.

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