We may be tempted to determine the optimal level of advertising expenditures at the point where the last dollar spent on advertising generates an additional dollar of sales revenue (i.e, the marginal revenue of advertising equals one). In general, this rule will not allow the firm to maximize profits because it ignores the:
A) price elasticity of demand.
B) marginal cost of additional sales generated by the advertising.
C) advertising-to-sales ratio.
D) fixed costs of advertising.

Question

Quizplus · Accepted Answer

The correct answer is B because the rule described ignores the marginal cost of additional sales generated by advertising. To maximize profits, a firm must consider both the additional revenue generated by advertising (marginal revenue) and the additional costs incurred to generate those sales (marginal cost). The optimal level of advertising expenditure is where the marginal cost of advertising equals the marginal revenue from the additional sales it generates, not simply where the marginal revenue of advertising equals one.

We May Be Tempted to Determine the Optimal Level of Advertising