Question

Discuss potential positive and negative influences if network effects providing specific examples.

Answer 1

A network effect is also called network externality. It refers to the concept that the value of the product or service improves with increased number of users or participants. A classic example is the internet. Initially, the internet was used in the military forces and research scientists. When the internet gained importance and others too started using it, the value of the internet improved as the content, information and services were developed to meet the needs of the people. The number of users increased in using the internet and they were all connected via the internet. The developments in the internet made it a highly valuable service to its users. This is known as positive externality wherein the increased number of users increases the product/service’s values. The value of the product is directly proportional to the number of users for positive externality.

On the other hand, negative externality or negative influences also might occur. As the number of users increases, the network loses its value. This concept can be used in ‘traffic congestion’ or ‘network congestion’ wherein as the number of participants increases, the performance of the product/services decreases considerably. For example, in a network if the number of users increases drastically and the networking is not aligned properly, then it might decrease the speed and performance of the internet.