Question

The elasticity of demand for a firm's product is - 4 and its advertising elasticity of demand is 0.32.

a. Determine the firm's optimal advertising-to-sales ratio. Instruction: Round your response to 2 decimal places.

Answer 1

The firm's optimal advertising-to-sales ratio, given a demand elasticity of -4 and an advertising elasticity of 0.32, is calculated to be 0.08 or 8%.

Step-by-step explanation:

To find the optimal advertising-to-sales ratio, we use the formula A/S = - advertising elasticity ÷ demand elasticity. In this case, we have A/S = -0.32 ÷ (-4). Performing the calculation yields A/S = 0.08, which means the firm's optimal advertising-to-sales ratio is 8%.

This ratio suggests how much the firm should spend on advertising relative to its sales revenue to maximize the effectiveness of its advertising efforts, given the sensitivities of its demand and advertising effectiveness. Given that the advertising elasticity of demand is 0.32 and the elasticity of demand is -4, we can substitute these values into the formula: 0.32 / (-4) = -0.08

Therefore, the firm's optimal advertising-to-sales ratio is -0.08.