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Profit Maximization Budget Setting for Advertising

Instructor: Sean Kennedy

Sean has 8 years experience as a supervisor and has an MBA with a concentration in marketing.

Profit maximization budget setting for advertising is crucial for business owners. In this lesson, we will discuss the importance of developing an advertising budget, profit maximization, and the sales-to-advertising response function.

Developing an Advertising Budget

Ashley is a new business owner and does not know where to start regarding her advertising budget. It is important for Ashley to remember that advertising will be paid for by the level of sales the advertising campaign will generate. Ashley must budget the money for advertising so that the company will be successful.

For instance, if Ashley has a successful campaign that is focused on her target market, then the campaign will help generate more sales for the company. A target market is the consumer demographic that a consumer is trying to reach. The target market is made up of the individuals that will be interested in a company's advertising campaign. If Ashley spends money on advertising, but it is not effective, then she invested money but won't reach profit maximization.

Profit Maximization

Advertising can be an expensive process, but advertising is essential to help keep consumers informed of a product or service. Profit maximization occurs when profits are maximized at the point where marginal revenue = marginal cost. Marginal revenue is the increase in revenue as a result of selling more products. Marginal cost is the cost of producing one more product for a company. At any point before profit maximization, profits are not maximized, because when companies invest more in their advertising budget, they will be able to receive more profit. Although advertising may cost money, Ashley, as a business owner, should look at it as an investment. It will help her gain more exposure from the public and can help increase sales. It is essential for her to determine the amount of money she will put out for advertising that will generate the most profit.

The best way for a company to analyze its success is through profit maximization. As a business owner, Ashley will want to know if that hard-earned money she is putting towards advertising is able to increase sales. The best option for any business owner is to take all of the costs for advertising and compare them to how much money the company is generating in profit.

Ashley has just opened a new clothing business. Ashley wants to make sure she reaches profit maximization in her advertising. Since Ashley is running a new business, it is especially crucial for her to make sure she does not overspend or underspend for her advertising. As the decision maker of the business, Ashley must use the sales-to-advertising response function to help set the budget for advertising.

Sales-to-Advertising Response Function

TC & TR = Total Cost and Total Revenue

TC & TR = Total Cost and Total Revenue

The sales-to-advertising response function represents the money invested in promotion compared to the amount of revenue generated. The sales-to-advertising response function will help Ashley determine the marginal profit, which results from subtracting the marginal cost from the marginal revenue. The goal is to have a marginal profit, which is also considered the output, of zero, because that means that the company was able to take advantage of all opportunities. The sales-to-advertising response function then analyzes the total amount spent in advertising compared to how much the company has generated in sales. The company should keep track and analyze the difference between money spent on advertising and the money generated from sales during each month.

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