In Chapter 13 we explained that a network externality exists when the value of a good or service is greater when a large number of other people also use the good or service. Although network externalities are common in technology-driven and communication-driven sectors of the economy, the phenomenon is considerably more widespread than that. Consider the case of a car. You might not think that the value of having a car depends on how many others also have cars, but in the early days of car consumerism it certainly did. That’s because when very few cars existed, service stations and repair shops were few and far between, and local governments had little or no incentive to upgrade their roads so that they were car-worthy. However, as more people purchased cars, service stations and repair shops sprang up and roads were improved. As a result, owning a car became even more valuable.

What a network externality shares with positive and negative externalities is an external effect: one person’s actions affect the payoff to another person’s actions. Network externalities play a key role both in the economy and in a number of regulatory policy controversies.