Under-connected and over-connected networks: the role of externalities in strategic network formation

Since the seminal contribution of Jackson and Wolinsky (J Econ Theory 71(1):44–74, 1996) it has been widely acknowledged that the formation of social networks exhibits a general conflict between individual strategic behavior and collective outcome. What has not been studied systematically are the sources of inefficiency. We approach this omission by analyzing the role of positive and negative externalities of link formation. This yields general results that relate situations of positive externalities with stable networks that cannot be “too dense” in a well-defined sense, while situations with negative externalities tend to induce “too dense” networks. Those results are neither restricted to specific assumptions on the agents’ preferences (e.g. homogeneity), nor to a specific notion of stability or efficiency.