Economics of networks

Economics of networks is an increasing new field on the border of economics and network sciences. It is concerned with understanding of economic phenomena by using network concepts and the tools of network science. Some main author in the field are Matthew O. Jackson and Rachel Kranton.

This term shouldn’t be confused with network economics or network externality, which is a theory explaining that a product or service has an increasing demand, that is, the more people use it, the more utility it brings.

Using the concept of networks during the analysis of markets can enable us to understand better its functioning. On the border of network science and market theory, several models have emerged explaining different aspects of markets.

Exchange theory explains how exconomic transactions, tradon of favors, communication of information or other goods’ exchanges are affected by the structure of relationship among the involved participants. The main concept is that the act of exchange depends on the agents’ other opportunities and their environment, and thus getting a deeper understanding is possible only by examining these factors. The position of a given agent in the network, for example, can endow her with power over the auctions and deals she make with her partners.

As part of exchange theory, in bilateral trading models we consider sellers and buyers and use game theory models of the bargaining on networks in order to predict the behaviour of agents depending on the type of network. The outcome of transactions can be determined by, for example, the number of sellers a buyer is connected to, or vica versa for which Corominas-Bosch built a very simple model. Another case is when the agents agree on the transaction through an auction and their decision making during the auction depends on the link structure. Kranton and Minehart came to the conclusion that if we consider markets as networks it can enable sellers to pool uncertainty in demand. As building links is costly, due to the trade-off not everybody need to be linked to everybody in the network. Sparsity in the network will prove to be efficient.

The first networks in economics were discovered when network science haven’t even existed yet. Károly Polány, Claude Levi-Stratuss or Bronislaw Malinowski studied such tribes where complicated gift exchange mechanisms constructed the network between groups, families or islands. Although by today trade system has transformed fundamentally, such systems based on reciprocity can still survive and reciprocity-based or personalised exchange deals persists even when a market would be more efficient. According to Kranton, informal exchange can exist in networks if transactions are more reciprocal than market-based. In this case, market exchange is hard to find and associated with high search costs, therefore yields low utility. The personalised exchange agreements ensure the possibility of long term agreements.

...
Wikipedia