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

Other things equal, in the Dorfman-Steiner framework, which change would lead a profit-maximising mutual fund house to reduce its optimal advertising-to-sales ratio?

More price-elastic demand with an unchanged advertising elasticity lowers the optimal ratio. Because the ratio is advertising elasticity divided by absolute price elasticity, a larger denominator reduces it, whereas revenue or cost changes alone do not affect it.

  1. AAdvertising becomes more effective at raising sales, increasing the advertising elasticity
  2. BDemand for its funds becomes more price elastic while the advertising elasticity is unchangedCorrect
  3. CIts revenue rises with no change in elasticities
  4. DAdvertising elasticity of demand doubles while price elasticity doubles too
  5. Its marginal cost falls with no change in elasticities

Explanation

The ratio is e_A/|e_P|. A larger |e_P| with unchanged e_A lowers it. Doubling both leaves it unchanged, and revenue or marginal cost changes do not alter the elasticity ratio.

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