Naive Analytics: The Strategic Advantage of Algorithmic Heuristics
67 Pages Posted: 30 Nov 2020 Last revised: 17 Sep 2023
Date Written: September 12, 2023
Abstract
We study interactions with uncertainty about demand sensitivity that is estimated by analytics algorithms. In our solution concept (1) firms choose seemingly optimal strategies given the level of sophistication of their data analytics algorithms, and (2) the levels of sophistication form best replies to one another. Under the ensuing equilibrium the firms’ algorithms underestimate price elasticities and overestimate advertising effectiveness, as observed empirically. The misestimates cause firms to overspend on advertising and to set prices too high. In games with strategic complements (substitutes), profits induced by this “naive analytics” equilibrium Pareto dominate (are dominated by) those induced by the Nash equilibrium.
Keywords: advertising, pricing, data analytics, strategic distortion, strategic complements, indirect evolutionary approach
JEL Classification: C73, D43, M37
Suggested Citation: Suggested Citation