Large-deviation theory of increasing returns.

Abstract

An influential theory of increasing returns was proposed by the economist W. B. Arthur in the 1980s to explain the lock-in phenomenon between two competing commercial products. In the most simplified situation there are two competing products that gain customers according to a majority mechanism: each new customer arrives and asks which product they bought to a certain odd number of previous customers, and then buys the most shared product within this sample. It is known that one of these two companies becomes a monopoly almost surely in the limit of infinite customers. Here we consider a generalization [Dosi, Ermoliev, and Kaniovsky, J. Math. Econom. 23, 1 (1994)10.1016/0304-4068(94)90032-9] in which the new customer follows the indication of the sample with some probability, and buys the other product otherwise. Other than economy, this model can be reduced to the urn of Hill, Lane, and Sudderth, and it includes several models of physical interest as special cases, such as the Elephant Random Walk, Friedman's urn, and other generalized urn models. We provide a large-deviation analysis of this model at the sample-path level, and we provide a formula that allows us to find the most likely trajectories followed by the market share variable. Interestingly, in the parameter range where the lock-in phase is expected, we observe a whole region of convergence where the entropy cost is sublinear. We also find a nonlinear differential equationfor the cumulant-generating function of the market share variable, which can be studied with a suitable perturbation theory.