How else might you propose increasi

How else might you propose increasing demand?

The effect of the above is to shift the TR function upwards. In Figure 5.20 maximum profit is now achieved at the higher output of Q2 and a higher price of P2. The degree to which price and output change depends upon the price elasticity of the new demand curve.

A combination of any of the above
The firm might use a combination of the above proposals (e.g. simultaneously seeking a cheaper supply of materials, moving to less expensive premises and seeking to increase demand through redesigning the product).

We illustrate such a possibility in Figure 5.21 where we assume the firm decides to regain profitability by increasing advertising advertising in the expectation that the additional expenditure will more than pay for itself by increasing sales revenue.

Production costs are independent of advertising costs, as advertising only affects demand conditions and not the production process of the firm as defined by its production function. It is also the case that advertising expenditures are made in a previous period and are therefore independent of current output and sales. As such, we may consider advertising expenditure as a fixed cost with a zero marginal cost in the current period. (Note that, as a general rule of thumb, the level of the next period is commonly set as a proportion of sales revenue in a previous period.)

Increasing advertising in Figure 5.21 therefore shifts the TC curve upwards to TC2 and so long as the advertising is successful the demand curve shifts outwards and the TR curve upwards. In this case the TR curve shifts to TR2 and the firm achieves maximum profit at an increased output of Q2 and a price of P2

Successive increases in advertising should shift the demand curve further to the right, but due to diminishing returns to advertising these successive shifts become smaller for equal increment in advertising. The optimal level of advertising would be determined where the additional revenue generated by the increased demand from advertising matches its extra cost.

The model we have developed therefore proves a valuable tool for analyzing a realistic scenario.