Question

You are interested in estimating the effect of advertising expenditures on sales of a particular item. You propose that the relationship between sales (measured by monthly sales revenue in a given city in 1000s of GBP), price (in GBP), and advertising expenditures advert (measured by monthly expenditures, also in 1000s of GBP) can be expressed by the following model:

sales = β0 + β1price + β2advert + β3advert2 + u
Based on a sample of 75 observations, you estimate this model by OLS. The equation below gives the estimated

coefficients and standard errors in parentheses:

sales = 110 − 7.64 price + 12.2 advert − 2.77 advert2. (6.8) (1.05) (3.56) (.941)

1. How would you express the estimated effect of an increase in advertising expenditure if the current expenditure is already £2,000p.m.? Interpret this estimated effect.

2. What level of advertising expenditure does this model suggest is optimal? (I.e. when does £1 advertising lead to £1 in sales at the margin?, assuming all other costs are sunk)

Answer 1