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Network effect in Economy

Network Effect is a phenomenon where present users of service benefit in some way when the product or service is adopted by additional users. It is widely known that the internet is a network of networks where people connect to each other,and it is the largest and best known example of network effect.

In class, we talked about the economy without network effects : we want to analyze markets with a huge number of potential purchasers, each of whom is small enough relative to the entire market that he or she can make individual decisions without affecting the aggregate behavior. We also discuss about the economy with network effects, which is a potential purchaser takes into account both her own reservation price and the total number of users of the good.

There are four types of network effects: Direct network effect, Indirect network effect, Bilateral network effect,and Local network effect. Direct network effect arises when users directly benefit from the addition of new users. Direct network effect is directly proportional to the users of the original product. Indirect network effect arises when users of the original product increase due to the effect of some complementary product that triggers the use of additional products. Bilateral network effect arises when there is an increase in users of the complementary products and users of that product benefit. Local network effect arises when a subset of network influences the user more than the whole network.

When the value of the product obtained is higher than the price of the product, the consumer base is expected to increase. New subscribers are attracted to the product because of the extra value they are getting. Due to huge dependence on prior subscriptions to critical mass level, companies need to compel the people to buy their product.

Finally, it is interesting to learn more about network effect in economy or our daily lives.


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