Advertising Elasticity of Demand (AED)

What Is Advertising Elasticity of Demand (AED)?

Advertising elasticity of demand (AED) is a measure of a market's sensitivity to increases or decreases in advertising saturation. Advertising elasticity is a measure of an advertising campaign's effectiveness in generating new sales. It is calculated by dividing the percentage change in the quantity demanded by the percentage change in advertising expenditures. A positive advertising elasticity indicates that an increase in advertising leads to a rise in demand for the advertised good or services.

Understanding Advertising Elasticity of Demand (AED)

The impact that an increase in advertising expenditures has on sales varies by industry. Companies frequently review their advertising-to-sales ratio to measure the effectiveness of their advertising strategies. Quality advertising will result in a shift in demand for a product or service. Advertising elasticity of demand is valuable in that it quantifies the change in demand (expressed as a percentage) by spending on advertising in a given sector. Simply put, it shows how successful a 1% rise in advertising spend is on raising sales in a specific sector when all other factors are the same.

For example, a commercial for a fairly inexpensive good, such as a hamburger, may result in a quick bump in sales. On the other hand, advertising for a luxury item — such as an expensive car or piece of jewelry — may not see a payback for some time because the good is costly and is less likely to be purchased on a whim.

Luxury goods have an income elasticity of demand, which means that as people's incomes rise, the demand for luxury goods increases as well.

Criticism of Advertising Elasticity of Demand (AED)

Because a number of outside factors, such as the state of the economy and consumer tastes, may also result in a change in the quantity of a good demanded, the advertising elasticity of demand is not the most accurate predictor of advertising's effect on sales. For example, in a sector where all competitors advertise at the same level, additional advertising may not have a direct effect on sales.

A good example of this is when a specific beer company advertises its product, which compels a consumer to buy beer, but not simply the specific brand they saw advertised. Beer has an industry-wide elasticity of 0.0, which means that advertising has little influence on profits. That said, AEDs can vary widely based on brand.

AED vs. Price Elasticity of Demand (PED)

While advertising elasticity of demand measures how advertising impacts the demand for products or services, price elasticity of demand (PED) measures how the price of a good or service impacts demand. Demand response to price fluctuations can be deemed as elastic or inelastic depending upon consumer reaction to the changing prices.

For example, suppose the price of a product increases significantly, but consumers continue to buy the product at the same levels as before despite the price increase. The price elasticity of demand is low or inelastic (that is, it doesn't change or stretch). Whether prices are high or low for that particular product, consumers continue to demand the product and their buying habits stay about the same. Goods that are basics required for survival, such as food or prescription drugs, are examples of products with inelastic demand.

Conversely, if a product has a high PED, an increase in price will result in lower consumer demand. Consumers will shift their purchases to substitute products with a lower price point, or they may go without the product entirely. This will often be the case with optional or discretionary purchases that a consumer can do without.

Companies that sell goods or services with a high PED may find it challenging to increase sales simply by increasing their advertising expenditures. In such cases, trying to achieve a positive AED may be ineffective if the company doesn't first address the high price point that is driving consumers away.

Special Considerations

The primary use for advertising elasticity of demand is making sure advertising and marketing campaign expenses are justified by their returns. A price comparison of AED and price elasticity of demand (PED) can be used to calculate whether more advertising would maximize profit. 

PED applied alongside AED can help determine what impact pricing changes may have on demand. For maximum profit, a company's advertising-to-sales ratio should be equal to minus the ratio of the advertising and price elasticities of demand, or A/PQ = -(Ea/Ep). If a company finds that their AED is high, or if their PED is low, they should advertise heavily.