Classroom Companion: Business

 
Chapter 9 · Network Effects

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a tripping point where it collapses and is thereafter rebuilt (e.g., the housing bubble 
in 2008). Note that oscillating or quasi-stable markets are also subject to positive 
feedback from the market.
Negative network effects may be generated by negative reviews and low ratings 
of the product, inferior experience expressed by friends, few active users, or users 
leaving the product stimulating others to do the same. Things that may amplify 
negative networks effects are insufficient advertisements (invisibility), poor user 
experience, technical issues (such as complex login), freeze-out, congestion, long 
response times, disturbing differential delays, interruptions, and frequent down-
times.
Positive network effects may include high ratings, high product visibility (band-
wagon effect), and excellent user satisfaction as expressed by friends (word of 
mouth).
Observe again that network effects, whether positive or negative, are caused by 
positive feedback from the market.
Feedback implies that some part of the output from a system is routed back 
to the input of the same system and thus causes an effect on the output. Feedback 
theory is important in almost all fields of science: physics, chemistry, technol-
ogy, social sciences, medicine, economics, and so on. The first deep analysis of 
feedback phenomena in natural systems was done by the American mathemati-
cian and physicist Norbert Wiener (Wiener, 
1948
). There are two types of feed-
back: positive feedback and negative feedback. These are well-defined technical 
terms.
Definition 9.4 Positive Feedback
Positive feedback is such that if there is a deviation in the output in one or the other 
direction, the feedback will make this deviation larger. In other words:
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The feedback is positive if more of A (input) produces more of B (output) and 
more of B produces more of A and so on until all of A has been consumed.
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The feedback is also positive if less of A causes less of B and less of B causes less 
of A until there is no more A left.
The most important observation is that positive feedback is the cause of both neg-
ative and positive network effects.
Positive feedback may also result in periodic or irregular oscillations. This is 
utilized in, for example, high frequency oscillators producing radio carrier waves 
for television broadcasting. Applied to economics, this may be the cause of certain 
types of business phenomena such as repeated economic crashes because of unsus-
tainable growth. One common reason for oscillations in the market (and in several 
other cases such as hunter/prey ecosystems) is long delay in the feedback loop. One 
example is the “pork cycle” in the early twentieth century where the demand and 
supply of pork meat were out of phase by one year because deficiency (and high 
price) of pork meat in one year caused overproduction (and low price) the next 
year. Another example is higher education where the delay is several years causing