Network Externalities - Explained
What are Network Externalities?
Written by J. Mance Gordon
Updated at May 6th, 2024
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What are Network Externalities?
Network externalities is an economics concept that describes the circumstances where the value of a product or service changes as the number of users increases or decreases.
According to the traditional economic theory, as the supply of a product increases, the price of the product falls and becomes less valuable.
In certain circumstances the opposite might happen, the value of a product or service may rise with the increase in the number of users. This is called the positive network externalities or the network effect.
Network Effect
The term network effect refers to positive network externalities where the value of a product or service increases with the rise in the number of users.
Negative network externalities are where more users decrease the value of a product, but it is commonly referred to as congestion.
Critical Mass
The network effects reach a significant level only when a certain number of people subscribe to the service or purchase the good. This certain subscription percentage is known as the critical mass.
After the critical mass point is reached, the value obtained from the product or service exceeds the price of the same.
The value of the good is determined by the user base, so after a certain number of people subscribe to the product, additional people will subscribe to it as the value exceeds the price.
It is important to reach the critical mass point for achieving success in such businesses.
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