BE/U2 Topic 14 Advertising Elasticity of Demand
Advertising elasticity of demand (AED) is a measure of a market’s sensitivity to increases or decreases in advertising saturation. Advertising elasticity is a measure of an advertising campaign’s effectiveness in generating new sales. It is calculated by dividing the percentage change in the quantity demanded by the percentage change in advertising expenditures. A positive advertising elasticity indicates that an increase in advertising leads to an increase in demand for the advertised good or service.
The impact that an increase in advertising expenditures has on sales varies by industry. Quality advertising will result in a shift in demand for a product or service. Advertising elasticity of demand is valuable in that it quantifies the change in demand (expressed as a percentage) by spending on advertising in a given sector. Simply put, how successful a 1% rise in advertising spend is on raising sales in a specific sector when all other factors are the same.
For example, a commercial for a fairly inexpensive good, such as a hamburger, may result in a quick bump in sales. On the other hand, advertising a piece of jewelry may not see a payback for a period of time because the good is expensive and is less likely to be purchased on a whim.
Because a number of outside factors, such as the state of the economy and consumer tastes, may also result in a change in the quantity of a good demanded, the advertising elasticity of demand is not the most accurate predictor of advertising’s effect on sales. For example, in a sector where all competitors advertise at the same level, additional advertising may not have a direct effect on sales. A good example of this is when a specific beer company advertises their product, which compels a consumer to buy beer, but not simply the specific brand they saw advertised. Beer has an industry-wide elasticity of 0.0, which means that advertising has little influence on profits. That said, AEDs can vary widely based on brand.
Advertising Elasticity of Demand Applied
The primary use for advertising elasticity of demand is making sure advertising expenses are justified by their returns. A price comparison of AED and price elasticity of demand (PED) can be used to calculate whether more advertising would maximize profit. PED applied alongside AED can help determine what impact pricing changes may have on demand. For maximum profit, a company’s advertising-to-sales ratio should be equal to minus the ratio of the advertising and price elasticities of demand, or A/PQ = -(Ea/Ep). If a company finds that their AED is high, or if their PED is low, they should advertise heavily.
Limitations of the AED value
However, while the AED value may be very useful, a simple numerical interpretation of the value may not be entirely appropriate for a number of reasons. These might include:
- The purpose of a lot of advertising may not be to directly boost demand, but to help with building a brand image or brand loyalty – the AED value cannot show the effectiveness of this strategy
- If dealing with a family of brands, it may be difficult to isolate the effect of the advertising spending on a single product or service and this may distort the apparent effectiveness of the expenditure
- It may be difficult to isolate the impact of advertising expenditure to a specific time period – some campaigns are ongoing over a considerable period and other factors may also influence demand over an extended period.