Of course it is better if children - and adults - do not see Pritzus. And of course it is better if they are shocked by it when they see it.
The older boy in your story did not "not notice" the woman - what he noticed just didn't shake him at all like it did the younger boy. It reminds me of a story of a certain Modern orthodox rabbi got Mussar from the Satmar Rebbe for shaking hands with women. The rabbi responded, "Rebbe, to you and your Chasidim, shaking hands with a woman is a big pritzus. To me, it's nothing. I don't even notice."
The Rebbe answered, "Tell me, rabbi, I'm curious - how many Aveiros does it take to reach that Madreigah?"
Similar incident with the Chofetz Chaim. He moved out of Radin to a bigger city for 2 weeks, then moved back. he said he couldn't take seeing the Chilul Shabbos in the big city. They asked the Chofetz Chaim, if Chilul Shabbos was his problem, why did it take 2 weeks? He should have left after the first Shabbos?
The Chofetz Chaim answered that the first week he saw the Chilul Shabbos and was very upset at it. The second week he was just a little less upset. He was ever-so-slightly getting used to the sight of Chilul Shabbos. That's when he knew he had to leave.
So its definitely better if you do not expose your children to Pritzus.
However, we live in a world where Pritzus is everywhere. So it's not enough to just shelter them from Pritzus. We have to teach them to resist it, and why they should resist it, when they encounter it - because inevitably, they will. But it is definitely not an option just to expose them to it. Pritzus is not like a vaccine where a little prevents a lot. As Chazal say: עבר קטן באדם וכו.
And even a vaccine, if it is not the proper dose, it can give you the disease.
So yes, the boy who is not used to the Pritzus is in a better position. But it's very hard nowadays to stay in that position. Doesn't mean we shouldn't try, though. And it certainly doesn't mean we should let our children think Pritzus is not a big deal. It is, even if it is endemic.
As far as the arcade game, I would surreptitiously distract his attention and bring him to another game. You don't have to make it obvious that there's something you want to hide him from there. If that doesn't work, we're talking about a 5 year old, so don't worry about it. The Chazon Ish ruled that children can go mixed swimming if they are not old enough to remember the images when they grow up. The odds are that a 5 year old is not going to remember that screen.
But it is best that you keep him away from such things to begin with.