Contents

1 Overview 9
1.1 Aspects of Networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
1.2 Central Themes and Topics . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

I Graph Theory and Social Networks 29

2 Graphs 31
2.1 Basic Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2.2 Paths and Connectivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
2.3 Distance and Breadth-First Search . . . . . . . . . . . . . . . . . . . . . . . 40
2.4 Network Datasets: An Overview . . . . . . . . . . . . . . . . . . . . . . . . . 48
2.5 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

3 Strong and Weak Ties 55

3.1 Triadic Closure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
3.2 The Strength of Weak Ties . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
3.3 Tie Strength and Network Structure in Large-Scale Data . . . . . . . . . . . 64
3.4 Tie Strength, Social Media, and Passive Engagement . . . . . . . . . . . . . 68
3.5 Closure, Structural Holes, and Social Capital . . . . . . . . . . . . . . . . . . 72
3.6 Advanced Material: Betweenness Measures and Graph Partitioning . . . . . 77
3.7 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

4 Networks in Their Surrounding Contexts 95

4.1 Homophily . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
4.2 Mechanisms Underlying Homophily: Selection and Social Influence . . . . . . 100
4.3 Affiliation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
4.4 Tracking Link Formation in On-Line Data . . . . . . . . . . . . . . . . . . . 108
4.5 A Spatial Model of Segregation . . . . . . . . . . . . . . . . . . . . . . . . . 117
4.6 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

5 Positive and Negative Relationships 129

5.1 Structural Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
5.2 Balanced Networks and the Cartwright-Harary Theorem . . . . . . . . . . . 133
5.3 Applications of Structural Balance . . . . . . . . . . . . . . . . . . . . . . . 136

3
4 CONTENTS

5.4 A Weaker Form of Structural Balance . . . . . . . . . . . . . . . . . . . . . . 140

5.5 Advanced Material: Generalizing the Definition of Structural Balance . . . . 143
5.6 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159

II Game Theory 163

6 Games 165
6.1 What is a Game? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166
6.2 Reasoning about Behavior in a Game . . . . . . . . . . . . . . . . . . . . . . 168
6.3 Best Responses and Dominant Strategies . . . . . . . . . . . . . . . . . . . . 173
6.4 Nash Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176
6.5 Multiple Equilibria: Coordination Games . . . . . . . . . . . . . . . . . . . . 178
6.6 Multiple Equilibria: The Hawk-Dove Game . . . . . . . . . . . . . . . . . . . 182
6.7 Mixed Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183
6.8 Mixed Strategies: Examples and Empirical Analysis . . . . . . . . . . . . . . 189
6.9 Pareto-Optimality and Social Optimality . . . . . . . . . . . . . . . . . . . . 194
6.10 Advanced Material: Dominated Strategies and Dynamic Games . . . . . . . 196
6.11 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210

7 Evolutionary Game Theory 219

7.1 Fitness as a Result of Interaction . . . . . . . . . . . . . . . . . . . . . . . . 220
7.2 Evolutionarily Stable Strategies . . . . . . . . . . . . . . . . . . . . . . . . . 221
7.3 A General Description of Evolutionarily Stable Strategies . . . . . . . . . . . 226
7.4 Relationship Between Evolutionary and Nash Equilibria . . . . . . . . . . . . 228
7.5 Evolutionarily Stable Mixed Strategies . . . . . . . . . . . . . . . . . . . . . 230
7.6 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235

8 Modeling Network Traffic using Game Theory 239

8.1 Traffic at Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239
8.2 Braess’s Paradox . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241
8.3 Advanced Material: The Social Cost of Traffic at Equilibrium . . . . . . . . 243
8.4 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253

9 Auctions 259
9.1 Types of Auctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
9.2 When are Auctions Appropriate? . . . . . . . . . . . . . . . . . . . . . . . . 261
9.3 Relationships between Different Auction Formats . . . . . . . . . . . . . . . 262
9.4 Second-Price Auctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264
9.5 First-Price Auctions and Other Formats . . . . . . . . . . . . . . . . . . . . 267
9.6 Common Values and The Winner’s Curse . . . . . . . . . . . . . . . . . . . . 268
9.7 Advanced Material: Bidding Strategies in First-Price and All-Pay Auctions . 269
9.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278
CONTENTS 5

III Markets and Strategic Interaction in Networks 283

10 Matching Markets 285
10.1 Bipartite Graphs and Perfect Matchings . . . . . . . . . . . . . . . . . . . . 285
10.2 Valuations and Optimal Assignments . . . . . . . . . . . . . . . . . . . . . . 290
10.3 Prices and the Market-Clearing Property . . . . . . . . . . . . . . . . . . . . 291
10.4 Constructing a Set of Market-Clearing Prices . . . . . . . . . . . . . . . . . . 295
10.5 How Does this Relate to Single-Item Auctions? . . . . . . . . . . . . . . . . 299
10.6 Advanced Material: A Proof of the Matching Theorem . . . . . . . . . . . . 300
10.7 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310

11 Network Models of Markets with Intermediaries 319

11.1 Price-Setting in Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319
11.2 A Model of Trade on Networks . . . . . . . . . . . . . . . . . . . . . . . . . 323
11.3 Equilibria in Trading Networks . . . . . . . . . . . . . . . . . . . . . . . . . 330
11.4 Further Equilibrium Phenomena: Auctions and Ripple Effects . . . . . . . . 334
11.5 Social Welfare in Trading Networks . . . . . . . . . . . . . . . . . . . . . . . 338
11.6 Trader Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 339
11.7 Reflections on Trade with Intermediaries . . . . . . . . . . . . . . . . . . . . 342
11.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 342

12 Bargaining and Power in Networks 347

12.1 Power in Social Networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347
12.2 Experimental Studies of Power and Exchange . . . . . . . . . . . . . . . . . 350
12.3 Results of Network Exchange Experiments . . . . . . . . . . . . . . . . . . . 352
12.4 A Connection to Buyer-Seller Networks . . . . . . . . . . . . . . . . . . . . . 356
12.5 Modeling Two-Person Interaction: The Nash Bargaining Solution . . . . . . 357
12.6 Modeling Two-Person Interaction: The Ultimatum Game . . . . . . . . . . . 360
12.7 Modeling Network Exchange: Stable Outcomes . . . . . . . . . . . . . . . . 362
12.8 Modeling Network Exchange: Balanced Outcomes . . . . . . . . . . . . . . . 366
12.9 Advanced Material: A Game-Theoretic Approach to Bargaining . . . . . . . 369
12.10Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376

IV Information Networks and the World Wide Web 381

13 The Structure of the Web 383
13.1 The World Wide Web . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384
13.2 Information Networks, Hypertext, and Associative Memory . . . . . . . . . . 386
13.3 The Web as a Directed Graph . . . . . . . . . . . . . . . . . . . . . . . . . . 394
13.4 The Bow-Tie Structure of the Web . . . . . . . . . . . . . . . . . . . . . . . 397
13.5 The Emergence of Web 2.0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400
13.6 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403
6 CONTENTS

14 Link Analysis and Web Search 405

14.1 Searching the Web: The Problem of Ranking . . . . . . . . . . . . . . . . . . 405
14.2 Link Analysis using Hubs and Authorities . . . . . . . . . . . . . . . . . . . 407
14.3 PageRank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414
14.4 Applying Link Analysis in Modern Web Search . . . . . . . . . . . . . . . . 420
14.5 Applications beyond the Web . . . . . . . . . . . . . . . . . . . . . . . . . . 423
14.6 Advanced Material: Spectral Analysis, Random Walks, and Web Search . . . 425
14.7 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 437

15 Sponsored Search Markets 445

15.1 Advertising Tied to Search Behavior . . . . . . . . . . . . . . . . . . . . . . 445
15.2 Advertising as a Matching Market . . . . . . . . . . . . . . . . . . . . . . . . 448
15.3 Encouraging Truthful Bidding in Matching Markets: The VCG Principle . . 452
15.4 Analyzing the VCG Procedure: Truth-Telling as a Dominant Strategy . . . . 457
15.5 The Generalized Second Price Auction . . . . . . . . . . . . . . . . . . . . . 460
15.6 Equilibria of the Generalized Second Price Auction . . . . . . . . . . . . . . 464
15.7 Ad Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 467
15.8 Complex Queries and Interactions Among Keywords . . . . . . . . . . . . . 469
15.9 Advanced Material: VCG Prices and the Market-Clearing Property . . . . . 470
15.10Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 486

V Network Dynamics: Population Models 489

16 Information Cascades 491
16.1 Following the Crowd . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 491
16.2 A Simple Herding Experiment . . . . . . . . . . . . . . . . . . . . . . . . . . 493
16.3 Bayes’ Rule: A Model of Decision-Making Under Uncertainty . . . . . . . . . 497
16.4 Bayes’ Rule in the Herding Experiment . . . . . . . . . . . . . . . . . . . . . 502
16.5 A Simple, General Cascade Model . . . . . . . . . . . . . . . . . . . . . . . . 504
16.6 Sequential Decision-Making and Cascades . . . . . . . . . . . . . . . . . . . 508
16.7 Lessons from Cascades . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 511
16.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513

17 Network Effects 517

17.1 The Economy Without Network Effects . . . . . . . . . . . . . . . . . . . . . 518
17.2 The Economy with Network Effects . . . . . . . . . . . . . . . . . . . . . . . 522
17.3 Stability, Instability, and Tipping Points . . . . . . . . . . . . . . . . . . . . 525
17.4 A Dynamic View of the Market . . . . . . . . . . . . . . . . . . . . . . . . . 527
17.5 Industries with Network Goods . . . . . . . . . . . . . . . . . . . . . . . . . 534
17.6 Mixing Individual Effects with Population-Level Effects . . . . . . . . . . . . 536
17.7 Advanced Material: Negative Externalities and The El Farol Bar Problem . 541
17.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 549
CONTENTS 7

18 Power Laws and Rich-Get-Richer Phenomena 553

18.1 Popularity as a Network Phenomenon . . . . . . . . . . . . . . . . . . . . . . 553
18.2 Power Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555
18.3 Rich-Get-Richer Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 557
18.4 The Unpredictability of Rich-Get-Richer Effects . . . . . . . . . . . . . . . . 559
18.5 The Long Tail . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 561
18.6 The Effect of Search Tools and Recommendation Systems . . . . . . . . . . . 564
18.7 Advanced Material: Analysis of Rich-Get-Richer Processes . . . . . . . . . . 565
18.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 569

VI Network Dynamics: Structural Models 571

19 Cascading Behavior in Networks 573
19.1 Diffusion in Networks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 573
19.2 Modeling Diffusion through a Network . . . . . . . . . . . . . . . . . . . . . 575
19.3 Cascades and Clusters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 583
19.4 Diffusion, Thresholds, and the Role of Weak Ties . . . . . . . . . . . . . . . 588
19.5 Extensions of the Basic Cascade Model . . . . . . . . . . . . . . . . . . . . . 590
19.6 Knowledge, Thresholds, and Collective Action . . . . . . . . . . . . . . . . . 593
19.7 Advanced Material: The Cascade Capacity . . . . . . . . . . . . . . . . . . . 597
19.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 613

20 The Small-World Phenomenon 621

20.1 Six Degrees of Separation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 621
20.2 Structure and Randomness . . . . . . . . . . . . . . . . . . . . . . . . . . . . 622
20.3 Decentralized Search . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 626
20.4 Modeling the Process of Decentralized Search . . . . . . . . . . . . . . . . . 629
20.5 Empirical Analysis and Generalized Models . . . . . . . . . . . . . . . . . . 632
20.6 Core-Periphery Structures and Difficulties in Decentralized Search . . . . . . 638
20.7 Advanced Material: Analysis of Decentralized Search . . . . . . . . . . . . . 640
20.8 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 652

21 Epidemics 655
21.1 Diseases and the Networks that Transmit Them . . . . . . . . . . . . . . . . 655
21.2 Branching Processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 657
21.3 The SIR Epidemic Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 660
21.4 The SIS Epidemic Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 666
21.5 Synchronization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 669
21.6 Transient Contacts and the Dangers of Concurrency . . . . . . . . . . . . . . 672
21.7 Genealogy, Genetic Inheritance, and Mitochondrial Eve . . . . . . . . . . . . 676
21.8 Advanced Material: Analysis of Branching and Coalescent Processes . . . . . 682
21.9 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 695
8 CONTENTS

VII Institutions and Aggregate Behavior 699

22 Markets and Information 701
22.1 Markets with Exogenous Events . . . . . . . . . . . . . . . . . . . . . . . . . 702
22.2 Horse Races, Betting, and Beliefs . . . . . . . . . . . . . . . . . . . . . . . . 704
22.3 Aggregate Beliefs and the “Wisdom of Crowds” . . . . . . . . . . . . . . . . 710
22.4 Prediction Markets and Stock Markets . . . . . . . . . . . . . . . . . . . . . 714
22.5 Markets with Endogenous Events . . . . . . . . . . . . . . . . . . . . . . . . 717
22.6 The Market for Lemons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 719
22.7 Asymmetric Information in Other Markets . . . . . . . . . . . . . . . . . . . 724
22.8 Signaling Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 728
22.9 Quality Uncertainty On-Line: Reputation Systems and Other Mechanisms . 729
22.10Advanced Material: Wealth Dynamics in Markets . . . . . . . . . . . . . . . 732
22.11Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 740

23 Voting 745
23.1 Voting for Group Decision-Making . . . . . . . . . . . . . . . . . . . . . . . 745
23.2 Individual Preferences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 747
23.3 Voting Systems: Majority Rule . . . . . . . . . . . . . . . . . . . . . . . . . 750
23.4 Voting Systems: Positional Voting . . . . . . . . . . . . . . . . . . . . . . . . 755
23.5 Arrow’s Impossibility Theorem . . . . . . . . . . . . . . . . . . . . . . . . . 758
23.6 Single-Peaked Preferences and the Median Voter Theorem . . . . . . . . . . 760
23.7 Voting as a Form of Information Aggregation . . . . . . . . . . . . . . . . . . 766
23.8 Insincere Voting for Information Aggregation . . . . . . . . . . . . . . . . . . 768
23.9 Jury Decisions and the Unanimity Rule . . . . . . . . . . . . . . . . . . . . . 771
23.10Sequential Voting and the Relation to Information Cascades . . . . . . . . . 776
23.11Advanced Material: A Proof of Arrow’s Impossibility Theorem . . . . . . . . 777
23.12Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 782

24 Property Rights 785

24.1 Externalities and the Coase Theorem . . . . . . . . . . . . . . . . . . . . . . 785
24.2 The Tragedy of the Commons . . . . . . . . . . . . . . . . . . . . . . . . . . 790
24.3 Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 793
24.4 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 796