Recently we’ve been talking about information cascades, and lately network effects, mostly in the context of tangible consumer goods and services. A more intangible example of both of these phenomena is going on right now, across the country. Although the first primary is more than eight months away, fund-raising has already started. This article in the Economist discusses the current state of the so-called ‘money primary,’ the race to amass funds for the upcoming campaign.

We can think of the money primary in terms of both network effects and information cascades. Someone who donates to a particular candidate’s campaign is putting some value on the election of that candidate. That is, they value the election of that candidate over another candidate that they did not donate money to. The value might be purely ideological, or it might be more crude–that isn’t particularly important here–but it’s clear that there is some value, or it wouldn’t be worth donating money. The game is a little trickier because donating money does not guarantee that your candidate gets elected. If your candidate loses, the money is lost, and essentially wasted. A savvy donor will therefore want to donate more to a candidate who is likely to win.

This is where network effects and information cascades both come into effect. If we make a simplifying assumption that a candidate with more money is more likely to win (an assumption that may have serious flaws, as the Economist article mentions, but is probably broadly accurate), then there is an immediate network effect. If everyone else is donating money to candidate A, then it makes more sense for me to donate money to A as well, even if I prefer B. Assuming that I attach a positive value to both candidates (for instance, if both A and B are from one party, and I want that party to win regardless of the candidate), then it makes sense to donate to A because A already has a lot of money. Donating to B is probably a lost cause, because B still won’t have much money compared to A.

This is also a place where information cascades can be seen. If we think that other donors have some private information about which candidate is likely to win, then seeing a lot of money giving to A will make us think that many donors think A will win. This means that donating to A is probably a good bet. So the perception that a candidate is ’strong’ can lead to it becoming true.

Last class we also discussed how network effects in a system can cause outcomes that are not socially optimal. I’m not touching that one.