Naive analytics equilibrium

Abstract

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.