Network Effects and Coordination Failure

Network effect

The value of a product depends on how many others use it: $V_i = f(N)$.

• Direct: each extra user directly adds value (communication networks)
• Indirect: more users attract complementary goods (more EVs → more chargers → EVs more valuable)
• Network effect ≠ automatically market failure: a problem only if it stops coordination on the better outcome

Coordination failure

Chicken & egg problem My best choice depends on yours: $\pi_i = f(a_j)$ (strategic complementarity).

• EVs: consumers wait for chargers, charger investors wait for EVs
• → Multiple equilibria: all invest (good) or nobody invests (bad). Both are stable: nobody gains by moving alone → the market can get stuck in the bad one → policy (e.g. charger subsidies) pushes it to the good one.

The difference

	Depends on	Example
Network effect	number of users	value of an EV rises with the charging network
Coordination failure	others’ investment decisions	green hydrogen: production + pipelines + offtakers + renewable power must all invest at once

Why it matters: different problem → different policy.

Links: Market Failure