Nonequilibrium phase transitions in competitive markets caused by network effects

Abstract

Network effects are the added value derived solely from the popularity of a product in an economic market. Using agent-based models inspired by statistical physics, we propose a minimal theory of a competitive market for (nearly) indistinguishable goods with demand-side network effects, sold by statistically identical sellers. With weak network effects, the model reproduces conventional microeconomics: there is a statistical steady state of (nearly) perfect competition. Increasing network effects, we find a phase transition to a robust nonequilibrium phase driven by the spontaneous formation and collapse of fads in the market. When sellers update prices sufficiently quickly, an emergent monopolist can capture the market and undercut competition, leading to a symmetry- and ergodicity-breaking transition. The nonequilibrium phase simultaneously exhibits three empirically established phenomena not contained in the standard theory of competitive markets: spontaneous price fluctuations, persistent seller profits, and broad distributions of firm market shares.