An Analysis of Optimal Advertising Under Uncertainty

Abstract

We examine the firm's optimal advertising behavior under conditions of uncertainty. For the static one-period model, we show that the firm's attitude toward risk may be responsible for the potential divergence between advertising decisions under uncertainty and those under deterministic conditions. For the dynamic multi-period model, the ultimate impact of uncertainty on advertising is further complicated when the sales response function contains an unknown parameter, and the firm wishes to gain more information about it through experimentation. We demonstrate that whether it is optimal for the firm to experiment at an advertising rate higher, equal to, or lower than the myopic (one-period) level would depend on the specification of the response function. Finally, we offer some empirical evidence for our assumption of a quadratic sales response function, using time-series data of twelve major brands of cigarettes.