Network effect

A network effect (also called network externality or demand-side economies of scale) is the effect described in economics and business that an additional user of a good or service has on the value of that product to others. When a network effect is present, the value of a product or service increases according to the number of others using it. The classic example is the telephone, where a greater number of users increases the value to each. A positive externality is created when a telephone is purchased without its owner intending to create value for other users, but does so regardless. Online social networks work similarly, with sites like Twitter and Facebook increasing in value to each member as more users join. The network effect can create a bandwagon effect as the network becomes more valuable and more people join, resulting in a positive feedback loop. The expression "network effect" is applied to positive network externalities as in the case of the telephone. Negative network externalities can also occur, where more users make a product less valuable, but they are more commonly referred to as "congestion" (as in traffic congestion or network congestion).


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