Social Information and Consumer Heterogeneity

We study the incentives of a social network to control two types of information circulating on its platform, namely display advertising by two quality-differentiated firms and “social information” (purchasing decisions shared among consumers). Consumers’ choices are influenced by both of these communication channels, whereas the network gets revenue only through advertising. We characterize the equilibrium level of network diffusion of social information and the firms’ expenditure on advertising. We show that depending on consumers’ heterogeneous response to advertising, social information can compete with or complement display advertising. Moreover, in every equilibrium each consumer almost surely purchases the superior product with a strictly higher probability, and that receiving social information almost surely further increases such probability. Finally, social information almost surely raises social welfare, thereby establishing the existence of a welfare-maximizing equilibrium.