Naive Analytics Equilibrium

Berman, Ron and Heller, Yuval (2021): 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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Advertising, pricing, data analytics, strategic distortion, strategic complements, indirect evolutionary approach.
• Subjects: C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C73 - Stochastic and Dynamic Games ; Evolutionary Games ; Repeated Games; D - Microeconomics > D4 - Market Structure, Pricing, and Design > D43 - Oligopoly and Other Forms of Market Imperfection; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M3 - Marketing and Advertising > M37 - Advertising

References

Jorge Alé-Chilet and Juan Pablo Atal. Trade associations and collusion among many agents: Evidence from physicians. mimeo, 2020.

Yair Antler and Beniamin Bachi. Searching forever after. mimeo, 2019.

Thomas Astebro, Holger Herz, Ramana Nanda, and Roberto A Weber. Seeking the roots of entrepreneurship: Insights from behavioral economics. Journal of Economic Perspectives, 28(3):49–70, 2014.

Yaron Azrieli. Categorizing others in a large game. Games and Economic Behavior, 67(2): 351–362, 2009.

Yaron Azrieli. Categorization and correlation in a random-matching game. Journal of Mathematical Economics, 46(3):303–310, 2010.

Pierpaolo Battigalli and Danilo Guaitoli. Conjectural equilibria and rationalizability in a game with incomplete information. In Decisions, Games and Markets, pages 97–124. Berlin: Springer, 1997.

Ron Berman. Beyond the last touch: Attribution in online advertising. Marketing Science, 37(5):771–792, 2018.

Steven T Berry. Estimating discrete-choice models of product differentiation. The RAND Journal of Economics, 25:242–262, 1994.

David Besanko, Sachin Gupta, and Dipak Jain. Logit demand estimation under competitive pricing behavior: An equilibrium framework. Management Science, 44(11):1533–1547, 1998.

Thomas Blake, Chris Nosko, and Steven Tadelis. Consumer heterogeneity and paid search effectiveness: A large-scale field experiment. Econometrica, 83(1):155–174, 2015.

Jeremy I Bulow, John D Geanakoplos, and Paul D Klemperer. Multimarket oligopoly: Strategic substitutes and complements. Journal of Political economy, 93(3):488–511, 1985.

Pradeep Chintagunta, Jean-Pierre Dubé, and Khim Yong Goh. Beyond the endogeneity bias: The effect of unmeasured brand characteristics on household-level brand choice models. Management Science, 51(5):832–849, 2005.

Russell Cooper and Andrew John. Coordinating coordination failures in keynesian models. Quarterly Journal of Economics, 103(3):441–463, 1988.

Eddie Dekel, Jeffrey C. Ely, and Okan Yilankaya. Evolution of preferences. Review of Economic Studies, 74(3):685–704, 2007.

Martin Dufwenberg and Werner Güth. Indirect evolution vs. strategic delegation: A comparison of two approaches to explaining economic institutions. European Journal of Political Economy, 15(2):281–295, 1999.

Ignacio Esponda. Rationalizable conjectural equilibrium: A framework for robust predictions. Theoretical Economics, 8(2):467–501, 2013.

Ignacio Esponda and Demian Pouzo. Berk–nash equilibrium: A framework for modeling agents with misspecified models. Econometrica, 84(3):1093–1130, 2016.

Erik Eyster and Matthew Rabin. Cursed equilibrium. Econometrica, 73(5):1623–1672, 2005.

Fershtman, C., and U. Gneezy (2001): “Strategic delegation: An experiment,” RAND Journal of Economics, 32(2), 352–368.

Fershtman, C., and K. L. Judd (1987): “Equilibrium incentives in oligopoly,” American Economic Review, 77, 927–940.

Fershtman, C., and E. Kalai (1997): “Unobserved delegation,” International Economic Review, 38, 763–774.

Frederik, J., and M. Martijn (2019): “The new dot com bubble is here: It’s called online advertising,” The Correspondent, November 6.

Friedman, E. (2018): “Stochastic equilibria: Noise in actions or beliefs?,” mimeo.

Fudenberg, D., and D. K. Levine (1993): “Self-confirming equilibrium,” Econometrica, 61(3), 523–545.

Golden, J., and J. J. Horton (2020): “The effects of search advertising on competitors: An experiment before a merger,” Management Science, forthcoming.

Gordon, B. R., F. Zettelmeyer, N. Bhargava, and D. Chapsky (2019): “A comparison of approaches to advertising measurement: Evidence from big field experiments at Facebook,” Marketing Science, 38(2), 193–225.

Güth, W., and M. Yaari (1992): “Explaining reciprocal behavior in simple strategic games: An evolutionary approach,” in Explaining Process and Change: Approaches to Evolutionary Economics, ed. by U. Witt, pp. 23–34. Ann Arbor: University of Michigan Press.

Hansen, K., K. Misra, and M. Pai (2020): “Algorithmic Collusion: Supra-competitive Prices via Independent Algorithms,” mimeo.

Hayward, M. L., D. A. Shepherd, and D. Griffin (2006): “A hubris theory of entrepreneurship,” Management Science, 52(2), 160–172.

Heifetz, A., and E. Segev (2004): “The evolutionary role of toughness in bargaining,” Games and Economic Behavior, 49(1), 117–134.

Heifetz, A., C. Shannon, and Y. Spiegel (2007): “What to maximize if you must,” Journal of Economic Theory, 133(1), 31–57.

Heller, Y. (2014): “Overconfidence and diversification,” American Economic Journal: Microeconomics, 6(1), 134–53. Heller, Y., and D. Sturrock (2020): “Promises and endogenous reneging costs,” Journal of Economic Theory, p. 105024.

Heller, Y., and E. Winter (2016): “Rule rationality,” International Economic Review, 57(3), 997–1026.

Heller, Y., and E. Winter (2020): “Biased-belief equilibrium,” American Economic Journal: Microeconomics, forthcoming.

Herold, F., and C. Kuzmics (2009): “Evolutionary stability of discrimination under observability,” Games and Economic Behavior, 67, 542–551.

Holmstrom, B. (1982): “Moral hazard in teams,” Bell Journal of Economics, 13, 324–340.

Jehiel, P. (2005): “Analogy-based expectation equilibrium,” Journal of Economic Theory, 123(2), 81–104.

Lewis, R. A., and J. M. Rao (2015): “The unfavorable economics of measuring the returns to advertising,” Quarterly Journal of Economics, 130(4), 1941–1973.

Lodish, L. M., M. Abraham, S. Kalmenson, J. Livelsberger, B. Lubetkin, B. Richardson, and M. E. Stevens (1995): “How TV advertising works: A metaanalysis of 389 real world split cable TV advertising experiments,” Journal of Marketing Research, 32(2), 125–139.

Monaco, A. J., and T. Sabarwal (2016): “Games with strategic complements and substitutes,” Economic Theory, 62(1-2), 65–91.

Nevo, A. (2001): “Measuring market power in the ready-to-eat cereal industry,” Econometrica, 69(2), 307–342.

Rao, J. M., and A. Simonov (2019): “Firms’ reactions to public information on business practices: The case of search advertising,” Quantitative Marketing and Economics, 17(2), 105–134.

Shapiro, B., G. J. Hitsch, and A. Tuchman (2019): “Generalizable and robust TV advertising effects,” mimeo.

Sinkinson, M., and A. Starc (2019): “Ask your doctor? Direct-to-consumer advertising of pharmaceuticals,” Review of Economic Studies, 86(2), 836–881.

Siroker, D., and P. Koomen (2013): A/B testing: The most powerful way to turn clicks into customers. John Wiley & Sons.

Spiegler, R. (2017): “Data monkeys: A procedural model of extrapolation from partial statistics,” Review of Economic Studies, 84(4), 1818–1841.

Spiegler, R. (2019): “Behavioral implications of causal misperceptions,” Annual Review of Economics, 12, 81–106.

Steiner, J., and C. Stewart (2015): “Price distortions under coarse reasoning with frequent trade,” Journal of Economic Theory, 159, 574–595.

Steiner, J., C. Stewart, and F. Matějka (2017): “Rational inattention dynamics: inertia and delay in decision-making,” Econometrica, 85(2), 521–553.

Thomke, S. H. (2020): Experimentation Works: The Surprising Power of Business Experiments. Harvard Business Press.

Villas-Boas, J. M., and R. S. Winer (1999): “Endogeneity in brand choice models,” Management Science, 45(10), 1324–1338.