A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward. Imagine the case of a platform like LinkedIn. For each additional user, joining, which also enriches the online resume, makes the platform more valuable to recruiters, as they can easily find qualified candidates. This is an example of a two-sided network effect.
Definition Network Effects: The value of a service/platform inreases for each additional user, as more users join in.
Sub-type
Description – Example
Direct, Same Side or One-Sided
As more users join, the platform’s value increases for each additional user. Take the case of a social media platform, like Facebook, Instagram, TikTok, LinkedIn, Twitter. The more users join, the more the platform will be valuable for each additional user, as the new user might find exponentially richer and broader content (provided the platform can prevent congestion or pollution).
Indirect or Cross-Side
In this case, a user type joining the platform makes it more valuable for other user types. Take the case of LinkedIn. While LinkedIn enjoys the same-side network effects, the platform becomes more valuable to users looking to enhance their careers as more users join in. At the same time, LinkedIn enjoys indirect or cross-side network effects. More users who join the platform to grow their career make it more valuable for recruiters (so a different user type) as they can find more qualified candidates on top of the platform.
Two-Sided
Take the case of LinkedIn. While LinkedIn enjoys the same-side network effects, the platform becomes more valuable to users looking to enhance their careers as more users join in. At the same time, LinkedIn enjoys indirect or cross-side network effects. In this case, a user type joining the platform makes it more valuable for other user types. More users who join the platform to grow their career make it more valuable for recruiters (so a different user type) as they can find more qualified candidates on top of the platform.
Multi-Sided
In this case, more than two user types are driven by the network dynamics. Take the case of Uber Eats; the more restaurants join the platform, the more the platform becomes valuable for eaters. While at the same time, by leveraging on its existing platform, Uber drivers have additional riding options. So they can earn extra income by delivering food instead of giving rides. That makes the overall platform much more valuable for the three main user types: eaters, restaurants, and riders.
Definition Negative Network Effects: The Value of the sercice/platform decreases for each additioanl user, as more users join in. This might be due to congestion (when increased usage can’t be handled by the platform) or pollution (when the increased size of the network makes it hard to incrementally add value, and instead its value shriks).
Description – Example
Congestion (Increased Usage)
In this case, there is a reduced quality of the service when certain parts of the networks carry way more data than they can handle. That usually happens because of scale limitations and noise due to curation limitations. Since this is a technological issue, it manifests as service slowdown or perhaps the platform crashing. Take the case of services like YouTube crashing for too much traffic. Or, if you’re a professional, a service like Slack crashes as it cannot handle the traffic spikes. That becomes a disservice with potential negative network effects because you suddenly prevent a whole team from functioning properly. Therefore, a negative network effect can have exponential negative consequences. For instance, users would switch to alternatives en masse if this was repeatedly happening, thus creating structural damage to the network.
Network Pollution (Increased Size)
The case of pollution is more tied to the ability of the platform to keep its service relevant at scale. Thus, imagine the case of a platform like Twitter, in which the principal asset is the feed. As Twitter becomes more and more popular, it needs to make sure that the user-generated content is qualitatively on target. Otherwise, the risk is for the user’s Twitter feed to become less relevant and lose value. Or imagine the case that many user-generated platforms face today, where spambots take over. Here, suppose the platform cannot handle this automatically generated content. In that case, it can quickly lose value, as the service becomes worthless for users (take the case of a user who has to spend an hour a day cleaning up the feed because of spamming).
Table of Contents
Platform business models and network effects
Network effects have become an essential element of a successful digital business, for several reasons. First, the Internet itself has become a facilitator for network effects.
As it becomes less and less expensive to connect users on platforms, those able to attract them in mass become extremely valuable over time.
Also, network effects facilitate scale. As digital businesses and platforms scale, they gain a competitive advantage, as they control more of the total shares of a market.
Last but not least, as we will see, network effects are considered among the defendable, or what confers to digital business, a competitive advantage.
Where in the past linear businesses gained a competitive advantage by buying assets and controlling supply chains. Digital companies gain competitive advantages by building network effects.
As we’ll see there are different kinds of network effects. And network effects can also be reverse or negative.
Competitive advantage = network effects
If you think about something like Instagram, the software is great but could fairly easily be replicated. But the network of users and the content they create is impossible to replicate. That is where the value is created. Or think about Reddit where the community creates the content. Or think about Waze where the users generate the data about which way has the least traffic.
In the era of platform business models in most cases, technology can bring an initial advantage. However, over time technology might become a commodity as it can be easily copied and replicated as it becomes wider adopted.
What can’t be easily copied is the community comprised of the network of users part of the platform. That is because users interacting produce several positive network effects.
Positive network effects
As more users join the platform the more it becomes valuable. Think of the case of a dating app with a few users in your town. How many chances there are the app would be able to match you up quickly? A few, thus the app won’t be much valuable to you
Data ownership
The interactions between users also generate data that the platforms can control, analyze, and own, which can be leveraged to create a lasting advantage. Therefore, the value of the network isn’t necessarily in the technology but in the data produced by the interactions
From transactions to interactions
As network effects become a primary advantage of the platform business, which can’t be easily replicated. The company needs to shift its mindset and manage the interactions in the platform. This is a key step to take. Think of the case of a company like Amazon, which over the years passed from being e-commerce to a platform business.
Indeed, most of. the transactions that happen today on Amazon are mostly from third-party sellers. While Amazon understood the value of network effects and of flywheel models early on.
A platform business model implies that the company in charge of the ecosystem that generates those network effects learns how to keep those interactions happening. This implies a shift in mindset to think in terms of product sales to interactions happening on the platform.
Network Effects enable digital businesses to gain value quickly. That is because they have built-in asymmetries between the costs and value of the network. Where costs might increase linearly, the value of the network increases exponentially as the network grows.
That’s because, in theory, platform business models manage to scale efficiently. Thus, where a traditional business, at a particular scale, it reaches a point of inefficiency where diseconomies of scale pick up.
A digital, platform business, might scale so efficiently, to be able to grow close to the total size of the market. This enables the formation of monopolies.
Thus, network effects become the real “assets” in the digital era. However, those “assets” won’t be seen on the company’s balance sheets.
Quite the opposite, platform business models enable exchanges among a large number of people within a network, but in most cases, they don’t control any of the assets owned by the people in the network.
Instead, those platform businesses only facilitate exchanges. And as a facilitator, they collect a “tax” as a transaction fee. That’s why modern platform business models might look and act more like nations, rather than corporations.
As James Currier, from NFX, points out, “Network effects have emerged as the native defense in the digital world.” Within network effects as a defensible NFX points out three key elements: scale, brand, and embedding.
It is essential to highlight that the types of networks above are not exhaustive, neither set in the stone. But the framework offered by NFX is a great starting point to understand how network effects work.
In this guide, I want to focus on two main kinds of network effects:
Direct or same-side.
And indirect or cross-side.
Direct or same-side network effects
Direct or same-side network effects happen when an increasing number of users or customers also increases the value of the product or service for the same kind of user.
Direct network effects usually follow Metcalfe’s law (one of the laws on the basis of network effects).
In short, Metcalfe’s law, developed in communications theory, states that, as users of a network grow, this enables the exponential growth in the number of potential connections, thus also an exponential increase in utility of the platform.
Indirect or cross-side network effects
Indirect or cross-side network effects happen when an increased number of users on the side of the platform drives up the value of the product or service offered for the other side of the platform.
Indirect network effects aren’t necessarily symmetric. In other words, in some cases, increasing one side of a platform might have more profound effects, than increasing the other side.
For instance, in Uber’s case, as a two-sided platform, driven by the exchanges between drivers and riders, the former plays a more critical role.
Indeed, Uber uses dynamic pricing strategies that make the service less convenient for riders, but it keeps drivers going back to the platform.
Also, indirect network effects might not necessarily be reciprocal. Thus, increasing the one side of the network might improve the service for the other side. But the same might not apply if the other side of the network is increased.
I want to clarify the critical difference between virality and network effects. Often (too often) those terms are used, or thought of as the same thing.
Network effects happen when a platform becomes more valuable as more users join it. Virality instead is a growth tool that companies can use to create more exposure for their product or platform.
Thus, a network effect is a way to create a lasting competitive advantage. And to offer more value to users. A viral effect is primarily a marketing tactic to gain traction and visibility for your product.
Network effects and virality can work together. For instance, as more users join through viral effects, if the platform is taking advantage of network effects, the more also it will become prone to improve its virality.
Network effects create value on the platform. Viral effects spread the word about the platform or the product externally.
And he continued:
So network effects, an example is the more users who are on Airbnb. The more hosts are setting up listings on Airbnb, the more choice there is for travelers. Now that’s a network effect.
Or take the example of YouTube, the more videos that are being set up on YouTube, the more choice I have as a viewer to view things on YouTube.
Instead, virality happens when:
Now, if I take a video from YouTube and embed it on Facebook, that’s not a network effect, that’s a viral effect.
In short:
So a viral effect is a growth tool that brings external users back to the platform. Whereas a network effect increases the value on the platform, just like adding more than more and more videos onto YouTube.
Beware of negative network effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining.
The more people using the highway system, the more traffic jams you end up in. Or the more people in a room, the less likely it is to have good decent conversation just because it gets crowded, but also because everybody is talking too loudly and so you can’t hear and you can’t meet the right person within that room.
He continues:
So we understand congestion in traditional terms because in the traditional world we have networks that were limited by scale.
When it comes to the digital world, instead, where there are fewer scale limitations. Or at least those can be initially overcome.
Thus, at least on the congestion side, it’s very hard to reach a point of negative network effects (for instance, if the platform crashes for usage).
Congestion, therefore, is primarily about the usage of the network.
In the bits world, it is possible not only to overcome congestion but also to build a more solid engineering infrastructure as usage increases. Of course, network congestions can also be bad for platforms (poor network design, over-subscription, security attach due to overused network parts).
Another form, of negative network effect, can take place for platform business models.
Network pollution
Where network congestion is primarily about the size of the platform.
As the platform scales, it gains network effects, as it becomes more valuable for an increasing number of users.
Yet, also for digital platforms scale might create situations of diseconomies.
What happens is the more users come on board, the more difficult it becomes to manage quality of the interactions.
Thus this makes the digital platform make sure to have a mechanism to manage the quality of those interactions to avoid that those negative network effects pick up.
If we think of social media, or publishing platforms at scale, among the most difficult task, that requires dozens if not hundreds of engineers and humans (Google might have thousands of human quality raters) to fix spam and low-quality user-generated content.
Examples of negative network effects
As highlighted negative network effects, dilute the value of the platform. And the way they can take over will depend on the kind of platform you’ve built. For instance:
Google case study
In a platform that leverages direct side network effects after a certain number of users, it might also result in increased spam on the platform which can’t be easily managed through automated processes, or human curation, thus diluting the value of the platform.
Take the case of how Google, back in the days, it was offering an index of the web with its core algorithm called PageRank. At a certain point had to figure out also how to manage the spam on its index.
Practitioners understood how to trick Google’s core algorithm into showing up spammy results on top of that. This would have jeopardized the value of the overall platform, thus resulting in a diluted value of that.
Thus Google had to start to build up a solid team dedicated to spam and update its algorithms to avoid spam in search results in order to keep its platform valuable.
Airbnb case study
In two-sided platforms, a kind of user joining the platform makes it more valuable for another type of user.
Take Airbnb where, for instance, more hosts improve value for users on the platform. On the two-sided more value is created by more hosts (travelers have more selection)? On the other hand, the value of the platform is diluted on the hosts’ side of the platform.
They will find themselves competing for the same users.
Thus it becomes crucial to understand what’s the proper ratio between travelers and hosts on the platform to make sure it keeps being valuable on both sides.
Tinder case study
Take the case of a dating app that draws value from having people encounter locally. If more users join but from locations spread across the world, no many local network effects are picking up.
Quite the opposite. If a critical mass is not reached at each local hub, the platform might lose value quickly. Imagine the case of a woman looking for a date. The faster she will be able to meet the best match.
The more the platform will be valuable. However, to be very valuable, the service has to make sure those people can meet in a place nearby. And it there are no matches available locally, the dating platform would lose value quickly.
Amazon from e-commerce to platform
When Amazon first started, its business model was an e-commerce.
Over the years, especially in the early 2000s, Amazon started to explore the option to feature more and more third-party stores, on top of Amazon.
By 2014, for the first time in its history, third-party sales passed the sales of Amazon own products. While the process of transitioning from e-commerce (simply selling its own products) to platform (enabling others to sell their own products), started in the early 2000s, it took over ten years for Amazon to complete this transition.
Amazon has a diversified business model. In 2021 Amazon posted over $469 billion in revenues and over $33 billion in net profits. Online stores contributed to over 47% of Amazon revenues, Third-party Seller Services, Amazon AWS, Subscription Services, Advertising revenues and Physical Stores.
Because, by the early 2000s, Amazon business model engine had to be structured in terms of network effects within its platform strategy.
Indeed, the more third-party sellers joined the platform, the more the platform became valuable to users, who could find more product variety.
And, Amazon could further pass lower prices to its customers. Once this process was repeated over and over, this is how Amazon built positive feedback loops into its business model.
And this was a paradigm shift!
Netflix, from platform to media company
While some companies transition to a platform strategy, and therefore, need to start thinking in terms of network effects.
Netflix is a subscription-based business model making money with three simple plans: basic, standard, and premium, giving access to stream series, movies, and shows. Leveraging on a streaming platform, Netflix generated over $29.6 billion in 2021, with an operating income of over $6 billion and a net income of over $5 billion.
Netflix started primarily with a platform strategy, offering licensed content on top of its platform.
It first transitioned from CD rental, to DVD subscription services. Then it moved to on-demand streaming, with an effective subscription model, with no surplus charges, neither late fees.
Yet, starting in 2013, Netflix started to invest more and more on producing its own content!
By 2021, content produced by Netflix represented 34% of the total investments made in content. This is a huge jump, considering that in 2019 alone, that number was 21%.
This, I like to call, the “mediafication of Netflix” where Netflix is completing its transition from platform (where it solely focuses on building the underlying infrustructure to enable others to offer their content) to media powerhouse (think of it as the new Hollywood!).
The on-demand streaming platform is still driven by network effects, but those are trickier. Indeed, those are more cultural network effects.
Imagine the case of more and more people watching Netflix original series, those who don’t will feel left out, and they will feel compelled to join in!
Key take on negative network effects
Platform business models can leverage network effects to enable the core platform to become more valuable over time. However, they need to factor in negative network effects, which if picking up might not only prevent the success of the business but also destroy it.
Key takeaways on network effects
The internet has become a facilitator for network effects.
Digital businesses work on a set of premises and principles that are different from traditional or linear businesses.
Network effects have become the “assets” for digital organizations.
Those network effects don’t sit on companies’ balance sheets. Rather digital businesses can trigger and build them up to create a strong competitive advantage.
Network effects enable digital businesses to scale efficiently and to get close to the total size of the market.
Network effects can be direct (when they when an increased size of the network improves the value of the platform for the same kind of users) and indirect (where the increased size of one side of the network improves the service for the other side).
Network effects are not the same thing as virality. Virality is a marketing tactic to acquire users or customers at a lower cost. Network effects represent a business strategy aimed at creating a long-term competitive advantage for digital businesses.
Understanding what a platform strategy entails
When it comes to platform business models it’s important to think in terms of markets and ecosystems. In short, as the platform usually makes money as fee-based on the interactions among key players on the platform, its main role will be the development of the market it sits on.
Market expansion consists of providing a product or service to a broader portion of an existing market or perhaps expanding that market. Or yet, market expansions can be about creating a whole new market. At each step, as a result, a company scales together with the market covered.
For instance, if we look at how various tech players evolved over the years based on a platform strategy, we can see how those first developed an ecosystem, and then “extracted” fees in the form of a tax from the key players once the new ecosystem had been built. Perhaps in the PC era, Microsoft’s Windows followed a platform strategy, where the PC worked as the hardware for Microsoft’s software products. On top of these, Microsoft built products, it helped other developers build their own products and it fostered an ecosystem to control the whole distribution.
As we moved from PC to smartphone other players like Apple use the same platform strategy. Perhaps, what made the iPhone interesting in the first place were the apps available in it. The App Store, therefore, evolved as a platform, that Apple fostered over the years, and that in 2020 made Apple $64 billion in revenues, as reported by CNBC.
This is what a platform strategy entails. That is why platform business models are evaluated in terms of the market they can capture.
A total addressable market or TAM is the available market for a product or service. That is a metric usually leveraged by startups to understand the business potential of an industry. Typically, a large addressable market is appealing to venture capitalists willing to back startups with extensive growth potential.
The wider the total addressable market, the more it will be interesting also for potential investors to finance the development of that ecosystem, as the platform will be able over time to extract value in form of revenues from that (here we’re not discussing whether that’s fair or not, but just how digital platforms evolved in the web era).
It’s worth noticing that platforms usually grow a business ecosystem by killing the fragmented intermediaries existing in a market (think of what Uber initially did with Taxis, and what Airbnb initially did with Hotels). While these players do eat up part of an existing marketplace, the main argument is also that those do expand the existing ecosystem, as they scale it up, thus bringing more potential customers into a system that before was clogged by too many intermediaries.
As a quick example, many Uber users might use it in ways that never had been done with Taxis (perhaps with users going so far as to sell their cars to only moving locally through Uber’s app).
That is also why marketing for a platform business model looks more like a flywheel, where there is a continuous loop between key players that feed each other’s thus making the flywheel spin faster. The classic example is the Amazon flywheel.
The Amazon Flywheel or Amazon Virtuous Cycle is a strategy that leverages customer experience to drive traffic to the platform and third-party sellers. That improves the selections of goods, and Amazon further improves its cost structure so it can decrease prices which spins the flywheel.
Other examples are below:
The virtuous cycle is a positive loop or a set of positive loops that trigger a non-linear growth. Indeed, in the context of digital platforms, virtuous cycles – also defined as flywheel models – help companies capture more market shares by accelerating growth. The classic example is Amazon’s lower prices driving more consumers, driving more sellers, thus improving variety and convenience, thus accelerating growth.
Key Highlights
Network Effects Definition: Network effects refer to the phenomenon where the value of a service or platform increases as more users join, making it more beneficial for both existing and new users.
Types of Network Effects:
Direct or Same-Side Network Effects: More users on the same side of the platform (e.g., users of a social media platform) increase the value for each user.
Indirect or Cross-Side Network Effects: More users on one side of the platform (e.g., job seekers on LinkedIn) increase the value for users on the other side (e.g., recruiters).
Negative Network Effects:
Congestion (Increased Usage): Reduced quality or performance of the service due to increased usage, potentially leading to service slowdown or crashes.
Network Pollution (Increased Size): Diminished value as the platform grows larger, affecting the quality of interactions, content, or services.
Network Effects in Platform Business Models:
Network effects are a core element of platform business models.
They contribute to a platform’s competitive advantage, as they can’t be easily replicated.
The community of users and the data they generate through interactions become valuable assets.
Positive vs. Viral Effects:
Positive network effects improve the platform’s value for users.
Viral effects are marketing tactics that create exposure and visibility for the platform.
Examples of Network Effects in Businesses:
Amazon transitioned from an e-commerce model to a platform model, leveraging network effects with third-party sellers.
Netflix shifted from a platform strategy to a media company strategy while maintaining cultural network effects.
Importance of Managing Negative Network Effects:
Businesses need to address potential negative network effects such as congestion or network pollution.
Solutions include quality control, spam prevention, and managing the balance of user types.
Digital Era and Network Effects:
The internet facilitates network effects by connecting users at lower costs.
Network effects enable digital businesses to scale efficiently and gain a competitive advantage.
They have become the primary “assets” for digital organizations.
Key Takeaway:
Network effects play a critical role in shaping the success of platform business models.
They offer a sustainable competitive advantage by making the platform more valuable as it grows.
Proper management of negative network effects is essential to maintain the platform’s value and user satisfaction.
Case Studies
Company
Network Value
Network Effects
Facebook
More users make the platform more valuable for social interaction.
Direct (Same-Side) Network Effects
LinkedIn
An increase in professionals on the platform benefits job seekers, recruiters, and businesses.
Direct (Same-Side) and Indirect (Cross-Side) Network Effects
Uber
More riders attract more drivers, reducing wait times and improving the service.
Direct (Same-Side) and Indirect (Cross-Side) Network Effects
eBay
A larger number of buyers and sellers result in a broader selection of products.
Direct (Same-Side) Network Effects
Amazon
Third-party sellers add to the product catalog, attracting more buyers.
Indirect (Cross-Side) Network Effects
Google
More users improve the quality of search results, attracting more advertisers.
Direct (Same-Side) and Indirect (Cross-Side) Network Effects
Apple App Store
A growing developer community leads to a richer app ecosystem, benefiting users.
Direct (Same-Side) Network Effects
Airbnb
More hosts attract more travelers, creating a robust marketplace for rentals.
Direct (Same-Side) and Indirect (Cross-Side) Network Effects
Snapchat
As more friends join, the platform becomes a more appealing way to communicate.
Direct (Same-Side) Network Effects
WhatsApp
The app’s value increases as more contacts within a user’s network adopt it.
Direct (Same-Side) Network Effects
Waze
User-contributed data about traffic and road conditions enhances the app’s accuracy.
Direct (Same-Side) Network Effects
Slack
The platform becomes more effective for collaboration as more organizations adopt it.
Direct (Same-Side) Network Effects
Twitter
A larger user base results in more diverse and real-time content, attracting more users.
Direct (Same-Side) Network Effects
Netflix
A wider selection of content and recommendations improve the platform for subscribers.
Direct (Same-Side) Network Effects
Spotify
More users lead to better playlists and music recommendations, enhancing the user experience.
Direct (Same-Side) Network Effects
Yelp
Increased user reviews provide more information and choices for consumers and businesses.
Direct (Same-Side) Network Effects
Google Maps
User-generated location data improves map accuracy and navigation for all users.
Direct (Same-Side) Network Effects
Instagram
More users contribute to a richer feed of visual content, making the platform more engaging.
Direct (Same-Side) Network Effects
Pinterest
A growing user base results in a more extensive collection of pins and ideas for users.
Direct (Same-Side) Network Effects
TikTok
As more creators join, the platform offers a wider variety of short-form videos to viewers.
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.
When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation.
Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.
Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.
An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage. Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.
In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.
Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.
Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.
The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.
The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.
How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.
The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”
Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.
Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.
The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth. The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.
Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846. Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.
The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
