Abstract

Networks in economics can be conceived as a useful adjunct to standard theory that helps incorporate the externalities generated by the interaction between individuals. Alternatively, the economy can be considered as a network where aggregate activity emerges from direct interaction between simple individuals often with only local knowledge. This constitutes a paradigm shift which, this chapter argues, is needed in economics. Rather than considering isolated optimizing individuals at equilibrium, experts should analyze the system, its structure, and its evolution over time, and thus understand sudden large endogenous movements in markets or the economy without recourse to exogenous shocks as an explanation. Examples include the evolution of the network of trading relations on a perishable goods market and the collapse of the mortgage-backed securities market. The structure and evolution of the network of interactions are perhaps more important than the specification of the characteristics of the individuals themselves.