Communication Networks with Endogeneous Link Strength

This paper analyzes the formation of communication networks when players choose endogenously their investment on communication links. We consider two alternative deÖnitions of network reliability; product reliability, where the decay of information depends on the product of the strength of communication links, and min reliability where the speed of connection is a§ected by the weakest communication link. When investments are separable, the architecture of the e¢ cient network depends crucially on the shape of the transformation function linking investments to the quality of communication links. With increasing marginal returns to investment, the e¢ cient network is a star ; with decreasing marginal returns, the conáict between maximization of direct and indirect beneÖts prevents a complete characterization of e¢ cient networks. However, with min reliability, the e¢ cient network must be a tree. Furthermore, in the particular case of linear transformation functions, in an e¢ cient network, all links must have equal strength. When investments are perfect complements, the results change drastically: under product reliability, the e¢ cient network must contain a cycle, and is in fact a circle for small societies. With min reliability, the efficient network is either a circle or a line. As in classical models of network formation, e¢ cient networks may not be supported by private invesment decisions. We provide examples to show that the star may not be stable when the transformation functions is strictly convex. We also note that with perfect substitutes and perfect complements (when the e¢ cient network displays a very symmetric structure), the e¢ cient network can indeed be supported by private investments when the society is large.