Network effects occur when the value of a product or service increases as more people use it. This phenomenon is particularly prevalent in technology and social media platforms, where each additional user adds value for all existing users. For example, social networks become more beneficial as more friends or contacts join, enhancing communication and interaction opportunities.
There are generally two types of network effects: direct and indirect. Direct network effects arise when the utility of a product increases directly with the number of users, while indirect network effects occur when the product's value increases due to the availability of complementary goods or services, such as apps or accessories.
Mathematically, if represents the value of a network with users, a simple representation of direct network effects could be , where is a constant reflecting the value gained per user. This concept is crucial for understanding market dynamics in platforms like Uber or Airbnb, where user growth can lead to exponential increases in value for all participants.
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