ECON254 THEORY OF THE FIRM. TUTORIAL 4.

ADVERTISING

Question 1
Illustrate with a diagram the impact of advertising on demand. How does advertising
achieve this?

Question 2
Classify the following goods and explain what theory suggests will be their advertising
intensities. Can you also think of any practical examples of strategies used:
i. Machine tools (e.g. for working metal in a production process)
ii. Breakfast cereals
iii. Cars
iv. Vitamin supplements

Question 3
For the purposes of this question we may briefly characterise the product life cycle
(reflecting the market for the product as a whole, not just the firm’s individual offering)
as consisting of:
 Introduction – when the product first comes on the market sales are low and grow
very slowly
 Growth – demand for the product takes off and sales grow rapidly
 Maturity/saturation – where the growth of sales volume tails off and weaker firms
are forced out of the market
 Decline – the market contracts.

Consider how price and advertising elasticities are likely to vary over the different
stages of the product life cycle and consider the implications for the level of
advertising in each stage with reference to the Dorfman-Steiner condition which
states that that the level of advertising should be higher:
 The lower the price elasticity of demand
 The higher the advertising elasticity of demand
 The lower the response of competitors raising their advertising in response to
your advertising
 The lower the effect of competitors’ advertising on your demand

Question 4
For each of the following state which type of ‘practical’ methods of determining
Advertising budget they are most likely following. Identify any issues of their approach.
i) A company is launching a new range of thermo-active clothing and has
projected year 1 sales to be £500,000 and has set their marketing budget to
£37,500.
ii) A company selling learning soft-toys has become increasingly concerned with
competitors’ sales after a successful advertising campaign and seeks to match
this with their own.
iii) A new manager has taken over a prominent mobile phone company and used
all of their reserves of cash to launch a massive advertising campaign.

© Dr S.L. Phythian-Adams & Balazs Muracozy, University of Liverpool, 2019