An Analysis of the Tradeoff between Advertising and Price Discounting

Abstract

The authors examine an important influence on the price-advertising tradeoff, the ratio of price and advertising elasticities. Their theoretical analysis stresses the centrality of the elasticity ratio and shows how the pass-through ratio, the fraction of loyal consumers who take advantage of price discounts, and the contribution-price ratio are additional factors that influence the price-advertising tradeoff. Empirical analysis of 262 observations from published studies indicates that the price elasticity is “on average” 20 times the advertising elasticity. The elasticity ratio is higher for mature products than for products in the early stage of the life cycle, and for nondurable goods than for durable goods. These findings suggest that price discounting may be more profitable than an advertising increase for nondurable goods and mature products. The ratio is smaller for elasticities estimated from yearly data than for those based on quarterly or monthly data. This finding raises a question about the appropriate level of aggregation for understanding the relative effects of price and advertising.