Abstract
In economics and management science, there has been increasing interest in network effects and social interaction effects. Network effects occur when to an economic agent (e.g., a consumer of a firm), the utility of using a product or technology becomes larger as its network of users grows in size (Farrell & Saloner, 1985; Katz & Shapiro, 1985). The network effect may set in motion a positive feedback loop that will cause a product or technology to become more prevalent in the market. Social interaction effects occur when an economic agent’s preference for a product or technology is dependent upon the opinions or expectations of other economic agents. The social interaction effect may set in motion a positive feedback loop that will cause agents to expect that a certain product or technology will become more prevalent in the market. In markets, network effects and social interaction effects appear for example in the emergence of fashions and fads (e.g., Abrahamson & Rosenkopf, 1997; Bikhchandani, Hirschleifer, & Welch, 1992) and in technology adoption and standardization (e.g., Arthur, 1989; Katz et al., 1985). Theory and existing research suggest that the presence of network effects and social interaction effects in markets has important implications for market structure, for market outcomes and, as a consequence, for the behavior and the performance of firms that are active in those markets (e.g., Arthur, 1996; Schilling, 1998; Shapiro & Varian, 1999). An important question is therefore under which conditions these network effects and social interaction effects occur in markets.
Key Terms in this Chapter
Conformity: Means that there are positive marginal social gains of an increase in network size.
Complementarity: Means that products or technologies are (meant to be) used together and that in this way they have for customers a higher value than when used separately. Economically this means that we may expect a positive cross-elasticity of demand between these products.
Marginal Gains of Network Size: The additional utility of adding one extra adopter to the network.
Compatibility: Means that products or technologies function in harmony with complementary products, because they share a common technological infrastructure.
Substitutability: Means that products or technologies are competitive, so that a consumer will buy either one product or the other. Economically, this means that we may expect a negative cross-elasticity of demand.
Social Interaction Effects: Occur when an economic agent’s preference for a product or technology is dependent upon the opinions or expectations of other economic agents. It is also referred to by others as social network effects or social contagion.
Individuality: Means that there are negative marginal social gains of an increase in network size.
Network Effects: Occur when, to an economic agent (e.g., a consumer or a firm), the economic utility of using a product or technology increases as its network of users grows in size.