No. 10-3 A Short Survey of Network Economics Oz Shy Abstract: This paper surveys a variety of topics related to network economics. Topics covered include: consumer demand under network effects, compatibility decisions and standardization, technology advances in network industries, two-sided markets, information networks and intellectual property, and social influence. Keywords: survey, network economics, network industries, network effects, network externalities JEL Classifications: D4, L1, L8, Z1 Oz Shy is an economist in the research department of the Federal Reserve Bank of Boston. His e-mail address is
[email protected]. This paper, which may be revised, is available on the web site of the Federal Reserve Bank of Boston at http://www.bos.frb.org/economic/wp/index.htm. I thank Jeff Church, Suzanne Lorant, Victor Tremblay, and two anonymous reviewers for most valuable comments and suggestions on earlier drafts. The views and opinions expressed in this paper are those of the author and do not necessarily represent the views of the Federal Reserve Bank of Boston or the Federal Reserve System. This version: March 31, 2010 1. Introduction Network effects are a special type of externality in which consumers’ utility and/or firms’ profits are directly affected by the number of consumers and/or producers using the same (or a compatible) technology. Loosely speaking, network effects are generated by increasing the adoption rate (popularity) of a good or a service. Consumption network effects may be positive, in the sense that consumers benefit from an increase in the number of consumers using the same or a compatible brand; or negative, in which case consumers are worse off when more consumers use the same or a compatible brand.1 Negative network effects often are the result of snobbism or vanity, in that a consumer loses the sense of belonging to an elite group when a product is adopted more widely.