Question

In a statement to Gillette’s shareholders, Chairman and CEO James Kilts indicated, “Despite several new product launches, Gillette’s advertising-tosales declined dramatically . . . to 7.5 percent last year. Gillette’s advertising spending, in fact, is one of the lowest in our peer group of consumer product companies.” If the elasticity of demand for Gillette’s consumer products is like other firms in its peer group (which averages - 4), what is Gillette’s advertising elasticity? Is Gillette’s demand more or less responsive to advertising than other firms in its peer group? Explain.

Short answer

The advertising elasticity is 0.3. The company’s demand is less responsive to advertising as its peer group.

Step-by-step solution

Introduction

The goal of this task is to determine the advertising elasticity of the company and compare it to its peer group.

We use the following formula to identify advertising to sales ratio:

$\frac{A}{R}=\frac{E_{Q,A}}{-E_{Q,P}}$

Where E_{Q, P}represents the own price elasticity of demand for the firm's product, E_Q,A is the advertising elasticity of demand for the firm's product, and A represents the firm's expenditures on advertising.

Advertising elasticity of demand

We use the given information in the formula$\frac{A}{R}=\frac{E_{Q,A}}{-E_{Q,P}}$ .

Given, $\frac{A}{R}=0.075$and E_Q,P=-4:.

So,

$0.075=\frac{{\text{E}}_{\text{Q,A}}}{-\left(-4\right)}$

Calculating the advertising elasticity of demand

$\begin{array}{c}0.075=\frac{{\text{E}}_{\text{Q,A}}}{4}\\ 0.075\times 4={\text{E}}_{\text{Q,A}}\\ {\text{E}}_{\text{Q,A}}=0.3\end{array}$

Thus, the advertising elasticity of demand equals 0.3 which means that the company’s demand is not as responsive to advertising as its peer group.