This project advances the economic theory of networks. Research in many other disciplines documents the importance of networks for economic activity. Yet, economists have only begun to develop theories of network interactions. This research will provide economists a new way of thinking about who does business with whom and why. It thus promises to change both economic theory and policy.
The first part of the proposal builds a network model of industry, where several manufacturers deal with several suppliers, and vice versa. The project takes a new look at a central policy question and theoretical puzzle -- how do vertical mergers affect economic welfare? It has long been argued - by both theorists and regulators - that vertical merger of two firms can lead to better internal coordination and investments. The project challenges this insight by considering the impact of merger on all investments, not just those internal to the merger. The project shows firms can strategically compete in these investment and demonstrates how a merged firm can manipulate its investments to increase its profits, but at a loss to other firms. The results should change the way theorists view industrial competition and inform how policy makers evaluate vertical mergers. The second part of this project studies social networks and the search for new technologies and information. Many studies have argued that communication and learning from others is important for economic activity and innovation. For example, before purchasing a new product or investing in a new technology, people inquire into the experiences of friends, neighbors, and colleagues. The project models this process. It introduces a new model where individuals experiment, then communicate their results to friends and colleagues. The project asks: how does the pattern of communication links determine the pattern of search and experimentation? Do people search themselves or rely on others? How do new links - links between communities or firms, for example - affect experimentation, search patterns and welfare? The answers to these questions should change the way people design institutions and policies to increase communication between different parts of the economy and society.
