TL;DR
This paper introduces a model of firms' strategic interactions under demand uncertainty, revealing systematic misestimations in elasticity and advertising effectiveness that influence pricing and marketing decisions, with implications for market outcomes and entrepreneurial overconfidence.
Contribution
It develops a novel equilibrium framework capturing firms' data analytics sophistication and its impact on market strategies and outcomes.
Findings
Firms underestimate price elasticities and overestimate advertising effects.
Misestimations lead to higher prices and excessive advertising.
Overconfidence explains entrepreneurial and salespeople behaviors.
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.
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