School of Business and Technology Management

Network Economics(MSB613), Spring 2018

Professor Duk Hee Lee

Course Outline

  • Class Time: Mon. Wed 10:30 – 11:45
  • Classroom: Alumni B/D(N22) #101
  • Lecture Hours & Credits: 3 hrs & 3 credits
  • Office: Alumni B/D, 405
  • Office Phone: 042-866-6306
  • E-mail: dhlnexys@kaist.ac.kr
  • Homepage: http://klms.kaist.ac.kr/
  • TA: Ohsung Kwon(N22, 4th floor 042-866-6360)

Course Objectives

This course aims to help students to understand basic principles of network economics and encourage them to apply the principles to real economic and business issues. In that sense this course is a quite interdisciplinary across many different fields. We first address ‘Network Economy’ including network externalities and increasing returns principle, and then several practical issues related to information good, technology competition, standardization, and spatial pattern. Secondly, we study a basic ‘Network Science’ and related issues such as network structure, social network analysis, strong tie and weak tie, homophily, and so on. Thirdly, we explore “Complexity’ in natural science and related issues that are handled in physics, neural network, ecosystem, and agent-based model. Further, we try to spend the rest of times to discuss some contemporary issues; Discrepancy and Instability, Congestion, System Risk. Innovation System, Information Cascades, etc.

Grading Policy (tentative)

Performance is graded on examinations, material presentation, term paper, assignments, and class participation. Each evaluating criteria are weighted as follows:

Mid-term Exam: 30%

Final Exam: 30%

Presentation/Term Paper/Assignments: 30%

Class Participation: 10%

Class Schedule

Ⅰ. Introduction (DHL)

Ⅱ. Network Economy

1. Network Externalities

1.1 Concept (Tirole 1988; Katz and Shapiro 1985)

1.2 Critical Mass (Allen 1988; Bass 1969; Rogers 1995; Schoder 2000; Williams et al. 1988)

1.3 Transformation of Demand Curve (Economides and Himmelberg 1995; Shy 2001 ch5)

1.4 Excess Inertia and Excess Momentum (Farrell and Saloner 1985; Postrell 1986; Tirole 1988)

1.5 Network Externalities and Compatibility (Katz and Shapiro 1985?; Shy 2001 ch2)

2. Increasing Returns World

2.1 Increasing Returns World vs. Decreasing Returns World (Arthur 1989, 1990, 1996)

2.2 Path Dependent Process: Lock-in Effect (Arthur 1986, 1988; Arthur et al. 1984; David 1985; Liebowitz and Margolis 1995, 1996)

3. Information Good

3.1 Pricing/Cost Structure (Shapiro & Varian 1999 Ch 2; Bank 1997; Bulkeley 1995; Melcher 1997; Varian 1980, 1985, 1995)

3.2 Intellectual Property Right Management (Shapiro & Varian 1999 Ch 4; Angwin 1997; Arrow 1972; Blumenthal 1992)

4. Network Competition

4.1 Lock-in and Switching Cost (Shapiro & Varian 1999 Ch 5; Klemperer 1987, 1989, 1995; Farrell and Shapiro 1988, 1989; Beggs and Klemperer 1992)

4.2 Network and Positive Feedback (Shapiro & Varian 1999 Ch 7; Katz and Shapiro 1985; Farrell and Saloner 1986; Arthur 1989, 1994)

4.3 Necessity Effects and Network Effects (Shy 2001; Katz and Shapiro 1994)

5. Standardization

5.1 Cooperation and Compatibility (Shapiro & Varian 1999 Ch 8; Basen and Farrell 1994; Farrell and Saloner 1988, 1992; Farrell, Monroe, and Saloner 1997)

5.2 Standards War and Strategies (Shapiro & Varian 1999 Ch 9; Carol 1993; Hamilton 1992;Lardner 1988; Lindquist and Johnson 1993)

5.3 Standardization Trend (DHL; Besen and Farrell 1994; Farrell and Saloner 1986)

6. Spatial Pattern

6.1 Necessity Effect vs Chance Effect (Arthur 1986, 1988)

6.2 Network Effect and Convergent Effect in Regional Growth (Arthur 1986, 1990;

Henderson et al. 1995; Castells 1988; Lee and Choi 2005)

Ⅲ. Network Science

7. Network Structure

7.1 Graph Theory (Erdős and Rényi 1959; Watts and Strogatz 1998; Barabasi and Albert 1999; Milgram 1967; Karonski and Rucinski 1997; Kumar et al. 2004, Odda 1979)

7.2 Network Topology Analysis (Barabasi 2002; Easley and Kleinberg 2010; Newman 2003, 2006, 2010; Jackson 2008, 2010; Freeman 1979; Kasper and Voelkl 2009;

Wasserman and Faust 1999)

8. Strong tie vs. Weak tie

8.1 Strength of Tie (Easley and Kleinberg 2010 Ch3; McEvily and Zaheer 1999?; McEvily et al.2003; Leij and Goyal 2011)

8.2 Strength of Weak Tie (Easley and Kleinberg 2010 Ch3; Granovetter 1973; Uzzi 1997)

8.3 Closure, Structural Hole, and Social Capital (Easley and Kleinberg 2010 Ch3; Ahuja 2000; Burt 1992; Newman 2003)

9. Homophily

9.1 Homophily: selection vs. social influence (Easley and Kleinberg 2010 Ch4; Friedkin

2006; Kandel 1978; McPherson et al. 2001; Moody 2001)

9.2 Selection vs. Social Influence (Easley and Kleinberg 2010 Ch4; Christakis and Fowler 2007)

9.2 Affiliation Network (Easley and Kleinberg 2010 Ch4; Feld 1981; Mizruchi 1996)

9.3 Empirical Data (Backstrom et al. 2006; Crandall et al. 2008; Kossinets and Watts 2006;

Leskovec et al. 2008)

9.4 Spatial Model of Segregation (Schelling 1971, 1978)

IV. Complexity

10. Complexity: Self-organization

10.1 Phase Transition: thermal convection, etc. (Nicolis and Prigogine 1989)

10.2 Earthquake and Sandpile (Bak and Chen 1991; Nicolis and Prigogine 1989)

10.3 Synchronization: Fireflies, Pacemaker Cell, Brain Wave (Strogatz 2003; Buck and Buck 1968; Peskin 1975; Mirollo and Strogatz 1990; Herz and Hopfield 1995;

Wiener 1958, 1961; Winfree 1967; Kuramoto 1984)

10.4 Complex Economy (Krugman 1996; Bak et al. 1993; Scheinkman and Woodford 1994)

11. Agent-based Model(ABM) (Axelrod and Tesfatsion 2005; Chan et al. 1999; Schelling 1978; Tesfatsion 2002; Windrum et al. 2007; Wolfram 1984, 1986)

12. Neural Network (Sporns 2002, Sporns and Tononi 2002, Tononi et al. 1998, Srinivasan et al. 1999, Sporns 2010; Koch and Laurent 1999)

13. Ecosystem (Wilson 1980)

V. Issues

14. Discrepancy and Instability

14.1 Network externalities and Antitrust Law (US Dept. of Justice 2004; Gilbert and Katz 2001; Viscusi et al. 2001)

14.2 Polarization and Vulnerability (DHL; Sornette 2003; Harras and Sornette 2011; Kim and Lee 2016)

14.3 Centralization vs. Decentralization (Watts 2003)

14.4 Micro Order vs. Macro Order (Surowiecki 2004; Burt 1992)

15. Systemic Risk (Benoit 2015; Bisias 2012; Scott 2016; Acemoglu et al. 2012, 2015; Billio et al. 2012; Lee et al. 2016; Kwon et al. 2017)

16. Innovation System (Reagans and McEvily 2003; Cowan and Jonard 2004; Tortoriello et al. 2012; Schilling and Phelps 2007; Lee et al. 2012; Lee and Lee 2017)

17. Information Cascades (Kim et al. 2017a, 2017b)

18. Congestion (Helbing 2001; Sugiyama et al. 2008; 西成活裕 2009)

List of Course Materials

•Acemoglu, D., V. M. Carvalho, A. Ozdaglar, and A. Tahbaz-Salehi(2012), “The Network Origins of Aggregate Fluctuations,” Econometrica 80(5), 1977–2016.

•Acemoglu, D., A. Ozdaglar, and A. Tahbaz-Salehi(2015), “Systemic Risk and Stability in Financial Networks,” Am. Econ. Rev. 105(2), 564–608

•Ahuja, G.(2000), “Collaboration Networks, Structural Holes, and Innovation: A Longitudinal Study”, Administrative Science Quarterly 45, 425-455

•Allen, D.(1988), “New Telecommunications Service: Network Externalities and Critical Mass”, Telecommunications Policy 13, 255-264.

•Angwin, J. (1997). McAfee Sweeps Away Viruses. San Francisco Chronicle, 14.

•Arrow, K. J. (1972). Economic welfare and the allocation of resources for invention. In Readings in Industrial Economics (pp. 219-236). Macmillan Education UK.

•Arthur, W. B.(1996), “Increasing Returns and the Two World of Business”, Harvard Business review, July-Aug.

•Arthur, W. B.(1990), “Positive Feedbacks in the Economy”, Scientific American, February.

•Arthur, W. B.(1989), "Competing Technologies, Increasing Returns, and Lock-in by Historical Event", Economic Journal 99, 116-131.

•Arthur, W. B.(1986), "Industry Location Patterns and Importance of History", Center for Economic Policy Research Paper 84. Stanford University.

•Arthur, W. B.(1988), "Urban Systems and Historical Path Dependence", in the “Cities and their Vital Systems”, edited by Ausubel, J. H. and Herman, R., Washington D. C.: National Academy Press. 85-97.

•Arthur, W. B.(1994), Increasing Returns and Path Dependence in the Economy. University of Michigan Press, 1994.

•Arthur, W. B. and Y. M. Ermoliev and Y. M. Kaniovski(1984), "Strong Law for a Class of Path-Dependent Stochastic Processes", Arkin and Shiryayev and Wets ed.(1984) Proceedings International Conference on Stochastic Optimization : Lecture Notes in Control and Information Sciences 81.

•Axelrod and Tesfatsion(2005), "A Guide for Newcomers to Agent-based Modeling in the Social Science" in the Handbook of Computational Economics Vol. 2: Agent-Based Computational Economics, edited by Tesfatsion, L. and K. L. Judd. Amsterdam: North-Holland.

•Backstrom, L., Huttenlocher, D., Kleinberg, J., & Lan, X. (2006, August). Group formation in large social networks membership, growth, and evolution. In Proceedings of the 12th ACM SIGKDD international conference on Knowledge discovery and data mining (pp. 44-54). ACM.

•Bak, P. and K. Chen (1991), “Self-Organizing Criticality”, Scientific American, January

•Bak, P. and K. Chen and J. Scheinkman and M. Woodford(1993), “Aggregate Fluctuations from Independent Sectoral Shocks: Self-Organizing Criticality in a Model of Production and Inventory Dynamics”, Richerche Economiche, March, 47(1), pp.3-30

•Bank, D. (1997). Microsoft’s Profit Tops Analysts’ Expectations. Wall Street Journal, 21.

•Barabasi, A. L.(2002), Linked: The New Science of Networks, East-Asia Publishing Co.

•Barabasi, A. L. and R. Albert(1999), “Emergence of Scaling in Random Networks”, Science 286, 509-512.

•Bass, F. M.(1969), “A New Product Growth for Model Consumer Durables”, Management Science 15, 215-227.

•Beggs, A. and P. Klemperer(1992). "Multi-Period Competition with Switching Costs.“, Econometrica 60(3): 651-666.

•Benoit, S., Hurlin, C., & Christophe, P. (2015). Where the Risks Lie : A Survey on Systemic Risk. Review of Finance, 1–59.

•Besen, S. M. and J. Farrell(1994), "Choosing How to Compete : Strategies and Tactics in Standardization", Journal of Economic Perspectives 8, 117-131.

•Billio, M., M. Getmansky, A. W. Lo, and L. Pelizzon(2012), “Econometric measures of connectedness and systemic risk in the finance and insurance sectors,” J. financ. econ 104(3), 535–559.

•Bisias, D., Flood, M., Lo, A. W., & Valavanis, S. (2012). A survey of systemic risk analytics. Annual Review of Financial Economics, 4(1), 255–296. Blind, K. (2004). The economics of standards. Books.

•Blumenthal, K. (1992). How Barney the Dinosaur Beat Extinction, Is Now Rich. Wall Street Journal, 28.

•Buck, J. and E. Buck(1968), “Mechanism of Rhythmic Synchronous Flashing of Fireflies”, Science 159, pp.1319-1327.

•Bulkeley, W. (1995). Finding Targets on CD-ROM Phone Lists. Wall Street Journal, 22.

•Burt, R. S (1992), Structural Holes, Cambridge, MA: Harvard University Press

•Carol, M. (1993), "Intel dominance could derail NT on Alpha train," Computerworld, pp. 1, 15.

•Castells, M. (1988). The new industrial space: information technology manufacturing and spatial structure in the United States. America's new market geography, 43-100.

•Chan, N. T., LeBaron, B., Lo, A. W., Poggio, T., Yy, A. W. L., & Zz, T. P. (1999). Agent-based models of financial markets: A comparison with experimental markets.

•Choe, H., Lee, D. H., Seo, I. W., & Kim, H. D. (2013). Patent citation network analysis for the domain of organic photovoltaic cells: Country, institution, and technology field. Renewable and Sustainable Energy Reviews, 26, 492-505.

•Choe, H., Lee, D. H., Kim, H. D., & Seo, I. W. (2016). Structural properties and inter-organizational knowledge flows of patent citation network: The case of organic solar cells. Renewable and Sustainable Energy Reviews, 55, 361-370.

•Christakis, N. A. and J. H. Fowler(2007), “The spread of obesity in a large social network over 32 years”, New England Journal of Medicine, 357(4):370-379.

•Cowan, R. and N. Jonard (2004), “Network structure and the diffusion of knowledge”, Journal of Economic Dynamics & Control 28, 1557 – 1575

•Crandall, D., D. Cosley, D. Huttenlocher, J. Kleinberg, and S. Suri(2008). “Feedback effects between similarity and social influence in online communities”, In Proc. 14th ACM SIGKDD International Conference on Knowledge Discovery and Data Mining.

•David, P.(1985), "Clio and the Economics of Qwerty", AEA Papers and Proceedings 75. 332-337.

•Easley, D. and J. Kleinberg(2010), Network, Crowds, and Market: Reasoning about a Highly Connected World, Cambridge University Press.

•Economides, N and Himmelberg , CP (1995), "Critical mass and network size with application to the US fax market", working paper

•Erdős, P.; Rényi, A. (1959). "On Random Graphs. I" Publicationes Mathematicae. 6: 290–297.

•Farrell, J. and G. Saloner(1985), "Standardization, compatibility, and innovation", RAND Journal of Economics 16, 70-83.

•Farrell, J., & G. Saloner(1986). Standardization and variety. Economics Letters, 20(1), 71-74.

•Farrell, J. & G. Saloner(1988), "Coordination Through Committees and Markets." Rand Journal of Economics 19(2): 235-252.

•Farrell, J. & G. Saloner(1992), "Converters, Compatibility, and the Control of Interfaces“, Journal of Industrial Economics 40(1): 9-36.

•Farrell, J, H. K. Monroe, and G. Saloner(1997). "The Vertical Organization of Industry: Systems Competition versus Component Competition." University of California at Berkeley.

•Farrell, J. and C. Shapiro(1988). "Dynamic Competition with Switching Costs." Rand Journal of Economics 19(1), 123-137.

•Farrell, J, and C. Shapiro(1989). "Optimal Contracts with Lock-In." American Economic Review 79(1). 51-68.

•Feld, S. L. (1981). The focused organization of social ties. American journal of sociology, 1015-1035.

•Freeman, L. (1979), “Centrality in social networks conceptual clarification”, Social Networks 1, 215-239

•Friedkin, N. E. (2006). A structural theory of social influence (Vol. 13). Cambridge University Press.

•Gilbert, R. J. and M. L. Katz(2001), “An Economist’s Guide to U.S. v. Microsoft”, Journal of Economic Perspectives, 15(2), 25-44

•Granovetter, M. S. (1973), “The Strength of Weak Ties,” The American Journal of Sociology, Vol. 78, No. 6, pp. 1360-1380

•Hamilton, R. (1992). IBM Ships Millionth OS/2; Microsoft Rather Amused. Computerworld, August, 17(4).

•Harras, G. and D. Sornette(2011), “How to grow a bubble: A model of myopic adapting agents,” J. Econ. Behav. Organ 80(1), 137–152.

•Helbing, D. (2001). Traffic and related self-driven many-particle systems. Reviews of modern physics, 73(4), 1067.

•Henderson, V., Kuncoro, A., & Turner, M. (1995). Industrial Development in Cities. The Journal of Political Economy, 103(5), 1067-1090.

•Herz, A. V. M. and Hopfield, J. J.(1995), "Earthquake Cycles and Neural Reverberations: Collective Oscillations in Systems with Pulse-coupled Threshold Elements," Physical Review Letters 75, pp1222-1225.

•Jackson, M. O. (2008,2010), “Social and Economic Networks”, Princeton University Press

•Kandel, D. B. (1978). Homophily, selection, and socialization in adolescent friendships. American journal of Sociology, 427-436.

•Karonski, M and Rucinski, A. (1997) “The origins of the theory of Random Graphs”, in the Mathematics of Paul Erdös, Springer,.

•Kasper, C. and Voelkl, B. (2009), “A social network analysis of primate groups”, Primates; journal of primatology 50(4) 343-356

•Katz, M. L. and C. Shapiro(1985), "Network Externalities, Competition, and Compatibility" American Economic Review 75, 424-440.

•Katz, M. L., & Shapiro, C. (1994). Systems competition and network effects. The journal of economic perspectives, 8(2), 93-115.

•Kim, J. and D. H. Lee (2016), “Relative wealth concerns, positive feedback, and financial fluctuation”, Journal of Simulation. Online published.

•Kim, J, O. Kwon, and D. H. Lee(2017a), “Social influence of hubs in information cascade processes”, Management Decision

•Kim, J, O. Kwon, and D. H. Lee(2017)b, “Transaction costs, network topologies, information cascades in the financial markets”, working paper

•Kelly, K. (1999). New rules for the new economy. Penguin.

•Klemperer, P.(1987). "Markets with Consumer Switching Costs“, Quarterly Journal of Economics 102(2): 375-394.

•Klemperer, P.(1989). "Price Wars Caused by Switching Costs“, Review of Economic Studies 56(3): 405-420.

•Klemperer, P.(1995), "Competition When Consumers Have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade“, Review of Economic Studies 62(4): 515-539.

•Koch, C. and G. Laurent(1999), “Complexity and the Nervous System”, Science 284, 96-98.

•Kossinets, G. and D. Watts(2006), “Empirical analysis of an evolving social network”, Science, 311:88-90.

•Krugman, P.(1996), The Self-Organizing Economy, Blackwell Publishers

•Kumar, R., J. Novak, P. Raghavan, and A. Tomkins(2004), “Structure and evolution of blogspace”, Communications of the ACM, 47(12):35-39.

•Kwon, O., Yun, S. G., Han, S. H., Chung, Y. H., & Lee, D. H. (2017). Network Topology and Systemically Important Firms in the Interfirm Credit Network. Computational Economics, 1-18.

•Lardner, J. (1987). Fast Forward: Hollywood, the Japanese, and the Onslaught of the VCR. WW Norton.

•Lee, D. H. and H. Choi(2005), "Network Size and Linkage Speed, and Critical Mass in Regional Growth", The Korean Economic Review, 53(2)

•Lee, D. H. and D. H. Lee(2017), “Structural properties of inter-organizational R&D networks and innovation performance: An empirical analysis of the European biotechnology field”, Working paper.

•Lee, D. H., Seo, I. W., Choe, H. C., & Kim, H. D. (2012). Collaboration network patterns and research performance: the case of Korean public research institutions. Scientometrics, 91(3), 925-942.

•Lee, J., Lee, D. H., & Yun, S. G. (2016). Systemic Risk on Trade Credit Systems: with the Tangible Interconnectedness. Computational Economics, 1-16.

•Leskovec, J., Backstrom, L., Kumar, R., & Tomkins, A. (2008). Microscopic evolution of social networks. In Proceedings of the 14th ACM SIGKDD international conference on Knowledge discovery and data mining (pp. 462-470). ACM.

•Liebowitz, Stan J., and Stephen E. Margolis (1995). "Path dependence, lock-in, and history." JL Econ. & Org. 11 : 205.

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•McEvily,B. & A.Zaheer (1999), 'Bridging Ties: A Source of Firm Heterogeneity in Competitive Capabilities,' Strategic Management Journal, Vol. 20, No. 12, pp.1133-1156

•McEvily, B. & V. Perrone & A. Zaheer(2003), Trust as an Organizing Principle, Organization Science 14(1), pp. 91-103

•McPherson, M., Smith-Lovin, L., & Cook, J. M. (2001). Birds of a feather: Homophily in social networks. Annual review of sociology, 415-444.

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•Newman, M. E. J.(2003), “The Structure and Function of Complex Network”, SIAM Review, 45:167-256.

•Newman, M. E. J.(2006), “Modularity and community structure in networks”, PNAS 23, 8577-8582

•Newman, M. E. J.(2010), “Networks: an introduction”, Oxford University Press

•Nicolis, G. and I. Prigogine(1989), Exploring Complexity: An Introduction, W. H. Freeman and Company.

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•西成活裕(2009), 澁滯學, 新潮社

이덕희(2008), 네트워크 이코노미: 부분과 전체의 복잡성에 대하여, 동아시아

Academic Honor Code of BTM (School of Business and Technology Management)

Academic integrity and honesty are critical values of KAIST community. It is essential to the academic integrity of this community that students do their own work and properly acknowledge the ideas, sources, and assistance upon which that work is based. As a member of KAIST BTM community, all students including those who take BTM courses are expected to adhere to the principles of truth, integrity, and respect. Failure to comply with the Honor Code may result in disciplinary action including failure of the course.

Academic dishonesty includes but is not limited to the following:

• Cheating: Copying from another’s examination paper, solutions, assignments, or allowing another to copy from one’s own.

• Plagiarism: Using another person’s original work without giving appropriate credit to or acknowledging the authors or


• Self-plagiarism: Submitting one piece of work in more than one course without the explicit permission of the instructors


• Misrepresentation of authorship: Submitting work as one’s own which has been prepared by or purchased from another.

• Unpermitted collaboration or aid: Giving or receiving unpermitted aid on exams or assignments.

Any member of the BTM community who believes that violation of academic dishonesty has occurred should bring the matter to the attention of the department chair. The department chair will assign members of Academic Review Committee (학사심의회) to conduct a thorough investigation and, if necessary, request a due process to university.