Does Lag Structure Really Matter in Optimizing Advertising Expenditures?

In this article, we examine whether a better econometric specification of the sales-advertising relationship leads to significantly improved decisions. Extending the pioneering work of Nerlove and Arrow, we analyze the sensitivity of the discounted profit flow to the dynamics of advertising. On the basis of a generalized variant of their constant-elasticity model, we compare various lag structures, and derive the corresponding decision rules to determine the optimal advertising budget. Financial consequences of misspecifications of the distributed-lag function are then evaluated. Our investigation is empirically illustrated on the basis of the data which served Palda for his demonstration of advertising cumulative effects.