Networks

Mike Anderson John Christie


 * __Definition__**

A **network effect** is a characteristic that causes a good or service that has value to customers. This value depends on the number of other customers who own the good or are users of the service. Many times the network effect leads firms to benefit from first-mover advantages.


 * __Examples__**

There are two varieties networks:

One-way networks (ex. residential water services) have services flowing in one direction. They are not directly dependent upon how many customers use their network. Also these network have high barriers to entry and have established firms enjoying economies of scale in their operations.

Two-way networks (ex. telephone services) have services flowing in both directions. They are directly dependent upon how many customers use their network. Also these networks allow firms to experience first-mover advantages and have established firms enjoying economies of scale in their operations. These networks can also be described as //hubs// and are characterized as the current telephone or airline industry.


 * __Real World Networks and Situations-Negative Externalities__**

Network effects can have negative externality consequences. For example, bottlenecks or outages can result from rapid, unsupported growth. If the internet's infrastructure cannot support growth and demand than a shortage of internet services can result. Other negative side effects could include power outages, loss of business, and loss of communication.

Currently and in the past (early 90's, into the 21st century), California residents are plagued by brown-outs in power during high temperatures, these brown-outs show how lack of infracture in supplying power to residents is a negative externality in an expansive, over-burdened network. This negative externality, cause some residents to be without power during high demand periods.

Another real-world example is cell phones and communication networks during September 11th, 2001. After the terrorist attacks of 9/11, worried citizens and cell phone customers tried to call for help, find relatives and friends, or call into the New York City area. Due to this great demand placed on the system, many were unable to call and communicate with individuals in the New York area. The cell phone communication network was overburdened anf failed.

A local negative externality consequence is illustrated through Indianapolis commuters. Even though the city has experience phenominal growth on the North and Southside of town, it has not invested in a strong public transportation system (monorail, buses, subway, etc.). This growth has been unsupported in areas (Carmel, Greenwood, Fishers, Greenfield, Westfield, Zionsville, etc.) until recently causing heavy traffic areas/patterns during the work week. Unfortunately, commuters are forced to utilize their own personal transporation methods which can be ineffecient causing traffic jams, increase likelihood of accidents, and long commute times.


 * __Real World Networks and Situations-Positive Externalities__**

One consequence of a network effect is that the purchase of a good by one individual indirectly benefits others who own the good - for example by purchasing a telephone, a person makes other telephones more useful. This type of side effect is known as an externality. Externalities arising from network effects are known as **network externalities**. The resulting bandwagon effect is an example of a positive feedback loop. For example, a telephone network with one user is useless. However, once users are part of the network, the value of the network increases and the per unit cost of the network decreases.

Network effects can have indirect externalities which result as consequences of growing networks. For example, the growth of the internet has led to society integrating itself in utilizing technology through the internet specifically facilitating growth in online education courses, web teleconferencing, use of electronic communication, and demand for software that incorporates the net. This growth and demand has not only made these side products more valuable, but also the internet.

As discussed, externalities from networks are not always negative, but can have beneficial effects that help individuals and situations. For example, companies using large data bases to store and query data to find information seek to find as much data as possible to fill their databases. This can help facilitate in datamining and gaining inferences on the data collected. Also contrary to common logic, the more data contained within a system that has the support capabilities, can actually facilitate queries, data gathering, and data mining causing programs to run faster and be more effecient.

A real-world example again from the cell phone industry is an example of Verizon. This company advertises //The Network//, which consists of customers nationwide and globally. The company advertises that being part of //The Network// allows you to leverage your capabilities to have better service and have a beneficial customer experience. The Verizon plans have special features that benefit customers to call other customers within //The Network.// This illustrates how it is beneficial to be a Verizon customer part of a large network. Being a part of a large network increases the likelihood of people you call having Verizon services, making it cheaper for each to call each other within the Verizon plans (mobile to mobile calling plans).


 * __Problems:__**

1. Which one of the following is not an example of a network? a. railroad company b. car dealership c. airline company d. trucking corporation e. telecommunications industry
 * Answer: b** The car dealership does not provide links connecting different points in geographic or economic space.

2. Which one of the following is not true of a one-way network? a. The service flow in only one direction b. The first-mover usually has an advantage c. the value to each user does not directly depend on the number of people that use the network d. A water company is a one-way network e. As more customers use a one-way network the value to each customer increases.
 * Answer: e**

3. Which one is an example of a two-way network a. Phone company b. Electric company c. Cable company d. Radio station e. None of the above
 * Answer: a**

4. In a network, the links that connect different points are called: a. connectors b. associations c. bonds d. None of the above e. attachments
 * Answer: d - //they are called nodes//**

5. (True/False) Indirect network externalities, also known as network complimentaries, can exists in one-way and two-way networks. **Answer: True**

6. Which of the following are examples of negative network externalities: a. traffic jams b. airport delays c. telephone busy signals d. Power outages e. All of the above
 * Answer: e**

7. Which of the following are examples of network complimentaries: a. growing use of electricity in the 20th century and increase use of electrical appliances b. DVD's increasing in popularity and movies being released on DVD c. All of the above d. None of the above
 * Answer: c**

8. If the value of a cell phone network is measured by the direct network externality equation of //n(n-1),// then Jill joining a cell phone network of 10 individuals will increase the value to ___ a. 110 b. 100 c. There is no change in the networks' value d. Jill joining the network bogs the systems causing a bottleneck and reduces value e. 90
 * Answer: a (The network was valued at 90, but Jill joining it increases the value to 11, thus [ 11*(11-1) = 110]**

9. If the average cost a customer is willing to pay is $10,000 to be part of a network and there are 100 nodes, then the total value of the network per customer is: a. 1,000,000 b. 10,000 c. There is no change in the networks' value d. 100,000 e. 990,000
 * Answer: be(The network has 100 nodes, the value of nodes is ($10,000*(100*(100-1))/100=$990,000**


 * __References:__**

1. Managerial economics and Business Strategy, Michaeal R. Baye, Fourth Edition, Chapter 13