Naive Analytics Equilibrium
52 Pages Posted: 30 Nov 2020 Last revised: 30 Mar 2021
Date Written: March 30, 2021
We study interactions with uncertainty about demand sensitivity. In our solution concept (1) firms choose seemingly-optimal strategies given the level of sophistication of their data analytics, and (2) the levels of sophistication form best responses to one another. Under the ensuing equilibrium firms underestimate price elasticities and overestimate advertising effectiveness, as observed empirically. The misestimates cause firms to set prices too high and to over-advertise. In games with strategic complements (substitutes), profits Pareto dominate (are dominated by) those of the Nash equilibrium. Applying the model to team production games explains the prevalence of overconfidence among entrepreneurs and salespeople.
Keywords: advertising, pricing, data analytics, strategic distortion, strategic complements, indirect evolutionary approach
JEL Classification: C73, D43, M37
Suggested Citation: Suggested Citation