Network effects

economic-dictionary

Network effects are said to occur when the value of a good or service depends on the number of people who use it.

In general, when there is a network effect, the greater the number of users, the greater value or utility that good or service will have.

Network effects were initially studied in the 1970s, in the context of long distance telephony. Today, they are a widely recognized phenomenon in the information and communication technology industry with a presence in various sectors such as software, electronic commerce, etc.

Types of network effects

There are several types, including the following:

  • Direct: These are the simplest and most direct network effects where an increase in the use of the good generates an increase in its value (or decrease). Thus, for example, the more users a social network has, the more valued it is by users.
  • Indirect: There are indirect network effects when the use of a product or service drives the production and value of other complementary ones, which in turn increases the value of the original product. Thus, for example, there are indirect network effects associated with the use of Windows whose value increases with the increased production and availability of new applications and other complementary products.

Network effect example

A good example of such effects is the internet. In its early days, it had very few users (mostly researchers and the military), so its value was relatively small.

As the number of users increased, more contacts were created, more sites to visit and more applications. In this way, the value of the Internet grew to become an essential tool today.

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