The Economics of Advertising

Question 1 Bandwagon advertising communicates the idea that many other people are using the advertised product. Examples include Pepsi’s mid-1980s campaign that proclaimed itself the “The choice of a new generation” and Proactive’s claim of being “America’s #1 Skin Care Product.” Another example is Apple’s tagline, "iPhone 5. Loving it is easy. That's why so many people do.” Using the complementary model of advertising, explain how bandwagon advertising works. Question 2 Suppose you’re the marketing director for a consumer products firm. Your firm expects its sales to be 10 000 000 € this year. Your marketing research suggests that a 1 percent increase in advertising would increase the quantity sold by 0.05 percent and that a 1 percent increase in price would reduce quantity demanded by 0.2 percent. a) How much money should you budget for advertising this year? b) Now suppose that the estimate of the demand elasticity is revised, and that a 1 percent increase in price suggests that quantity demanded would fall by 0.5 percent. How would your advertising budget change considering the new estimate? c) Based on the different price elasticities in parts (a) and (b), explain how the price elasticity affects advertising expenditures.