Figure 117

Optimal Level of Advertising

A firm will expand the level of advertising up to the point where the net marginal revenue generated just equals the marginal cost of advertising.

Profit margin per unit of output Expand advertising Reduce advertising

Profit margin per unit of output Expand advertising Reduce advertising

Advertising expenditures ($)

This market demand implies total and marginal revenue functions of

TR = P X Q = $250Q - $0.01Q2 MR = ATR/AQ = $250 - $0.02Q

Assume total and marginal costs before advertising expenses are given by the expressions

The optimal price/output combination is found by setting MR = MC and solving for Q. Because marginal costs are constant at $50 per unit, the pre-advertising optimal activity level for Regain is

P = $250 - $0.01Q = $250 - $0.01(10,000) = $150 n = TR - TC

= $250(10,000) - $0.01(10,0002) - $250,000 - $50(10,000) = $750,000 per month

Following a 100 percent advertising-inspired increase in demand, the new monthly demand relations for Regain are

This new advertising-induced market demand implies new total and marginal revenue functions of

The new optimal price/output combination is found by setting the new MR = MC and solving for Q. Because marginal costs remain constant at $50 per unit, the new optimal activity level for Regain is game theory

General framework to help decision making when firm payoffs depend on actions taken by other firms

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