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CHAPTER 5 Information Contagion W Brian Arthur and David A. Lane This paper explores a positive feedback mechanism quite different from the ones discussed earlier in this book. It works through the way information is transmitted in a typical technical-product market. When prospective buyers are making purchasing decisions among several available technically-based products, choosing among different computer workstations, say, they often augment whatever publicly available information they can find by asking previous purchasers about their experienceswhich product they chose, and how it is working out for them. This is a natural and reasonable procedure; it adds information that is hard to come by otherwise. But it also introduces an "information feedback" into the process whereby products compete for market share. The products new purchasers learn about depend on which products the previous purchasers "polled" or sampled and decided to buy. They are therefore likely to learn more about a commonly purchased product than one with few previous users. Hence, where buyers are risk-averse and tend to favor products they know more about, products that by chance win market share early on gain an informationfeedback advantage. Under certain circumstances a product may come to dominate by this advantage alone. We call this phenomenon information contagion and explore it in depth in this paper. The paper appeared in working paper form in 1991 as Santa Fe Institute Paper 91-05-026 under the title "Information Constriction and Information Contagion." The version here is the published one; it is from Economic Dynamics and Structural Change, 1993. David A. Lane is with the School of Statistics, University of Minnesota, Minneapolis. This work was prepared under the auspices of the Santa Fe Institute's Economics Research Program which includes grants from Citicorp/Citibank Research Corp., the Alex C. Walker Foundation and the Russell Sage Foundation; and of grants to SFI from the John D. and Catherine T. MacArthur Foundation, the National Science Foundation (PHY-8714918), and the U.S. Department of Energy (ER-FG05-88ER25054). Lane also received support from National Science Foundation grant DMS-8911548. We also thank Nicola Dimitri, Ed Green, Larry Gray, Francesco Corelli, Marcel Fafchamps, Ashok Maitra, and participants in the Stanford mathematical economics seminar for helpful comments and conversations about the ideas presented here. 69 70 Increasing Returns and Path Dependence in the Economy 1. Introduction For the potential purchaser, a new technically based product can be a source of considerable uncertainty. Specifications, advertising brochures, and consumer reports may be available, and the cost of purchase precisely known. Yet the purchaser may still be unsure about how the product will perform for him: how smoothly it can be integrated into his existing operations; how much maintenance or "down time" the product will require; whether the product in fact is suited to the particular uses he has in mind. For example, in choosing among computer programs th~t create environments for "doing mathematics" or statistical data analysis on desktop computers, the prospective user may be well-informed about prices and technical features; but typically he does not know in advance the various practical difficulties and unexpected advantages that will inevitably emerge after he takes up a given program. In cases like these, usually the potential purchaser tries to reduce this uncertainty by asking previous purchasers about how they have fared with the products they bought and subsequently used. This sampling or "polling" of the experiences of past purchasers is natural and reasonable: it helps fill in information that is otherwise missing. But it also introduces an "informational feedback" into the process whereby the products compete for market share. Which product the prospective purchaser decides to buy depends on information obtained from previous purchasers; but the information he encounters depends on which of the products these purchasers decided to buy. Under certain circumstances this informational feedback can cause market shares to become self-reinforcing. Prospective purchasers are more likely to learn about a commonly purchased product than one with few previous users; so that, if they are risk averse, products that by chance win market share early on are at an advantage. Under certain circumstances , in fact, a product may come to dominate by this advantage alone. This informationally generated linkage between a product's prevalence and its likelihood of purchase we call information contagion. Notice of course that, even though private information is added to the public information by this "polling" of previous users, in sampling only a small subset of all past purchasers much of the available...

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