Advertising Versus Sales in Demand Creation

We investigate the dynamics of a firm whose advertisements and sales contribute to its customers’ stock of goodwill. An advertising campaign precedes the firm’s sales when the marginal product of advertisement is sufficiently large (e.g., Amazon Kindle and Apple Macintosh), whereas sales of a new brand of a familiar product may start without advertising (e.g. Crocs shoes). When the firm chooses both advertising and sales policies, the optimal solutions can be divided into two groups typified by low and high demand elasticities. When demand elasticity is low, a massive increase in the quantity sold causes a considerable drop in the product's price. Therefore, the firm prefers to use advertising, rather than excess sales. With high demand elasticity, a massive increase in the quantity sold reduces the price only marginally, thus sales becomes a relatively cheap way to build up the stock of goodwill, compared with advertising.