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Question #2 (L02, LO3, LO7 For the sake of developing the optimal rate of advertising for a business firm, Dorfman-Steiner mo


Managerial Economics 8e AND Business Strategy MICHAEL R. BAYE JEFFREY T. PRINCE
Question #2 (L02, LO3, LO7 For the sake of developing the optimal rate of advertising for a business firm, Dorfman-Steiner model has been developed. Set the objective function of the model? 1- Set the first-order conditions for the optimization? 2- 3- Discuss the main model results which are relevant guiding indicators of a business firm for its advertising spending based on the following main relations: (P-MC) E= E £E, = %AP A Ed PQ P %AA
Managerial Economics 8e AND Business Strategy MICHAEL R. BAYE JEFFREY T. PRINCE
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Answer #1

The objective tmctron the model is TCeAeCA, P- [aG) A fime maximi3e peafit Cumetin e(PA2 uartity uhih is Th ot s rofito P & A

&ed Mc is M C ed Magin a P cast & ed M C ed t P MC ed ed + Mc ed-ed = 1 MC P Ed P 1 Cp - M. C ed pinast second in wea Wse whi

1/20 Cest CM Manginal |*Ne wil convert it inte dif eret a boenn ohere which is elastia ty Neaput to Advetsing reA ide introdu

Uaing O, ne kmow P- MC や2. n Sutstitute t CA A ed) A R. eA Pxa) ed whe A s A dueutising Aperding, Ri Reueue ea+ larti aty t d

Two aspects of this result:

1. More elastic the demand curve, the lower will be advertising to sales ratio. For the extreme case where ed is infinite we can verify that A/R will be close to 0.

2. Greater the advertising elasticity, higher will be A/R ratio. That is, firms will spend more on advertising relative to Sales.

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