Question

The contribution marginal percentage for a firm is .4, or 40%, and its advertising elasticity of...

The contribution marginal percentage for a firm is .4, or 40%, and its advertising elasticity of demand is 0.2.

3a Determine the firm’s optimal advertising-to-sales ratio.

3b If the firm’s revenues are $40,000, what is the profit maximizing level of advertising?

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Homework Answers

Answer #1

3(a)

Formula:

Optimal advertising to sales ratio = Advertising elasticity/ Price elasticity

Price elasticity = 1/(contribution margin ratio)

=> Price elasticity = 1/0.4 = 2.5

It is given that advertising elasticity of demand is 0.2.

Hence, Optimal advertising to sales ratio = Advertising elasticity/ Price elasticity = 0.2/2.5 = 0.08.

Hence, Optimal advertising to sales ratio = 0.08

3(b)

Advertising/ Sales = 0.08 (Calculated above) and Sales = Revenue = $40,000
=> Advertising = 0.08*40,000

= 3200

Hence, the profit maximizing level of advertising = $3200

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