Word-of-Mouth Communication and Social Learning

Abstract

This paper studies the way that word-of-mouth communication aggregates the information of individual agents. We find that the structure of the communication process determines whether all agents end up making identical choices, with less communication making this conformity more likely. Despite the players' naive decision rules and the stochastic decision environment, word-of-mouth communication may lead all players to adopt the action that is on average superior. These socially efficient outcomes tend to occur when each agent samples only a few others. I. INTRODUCTION Economic agents must often make decisions without knowing the costs and benefits of the possible choices. Given the frequency with which such situations arise, it is understandable that agents often choose not to perform studies or experiments, but instead rely on whatever information they have obtained via casual word-of-mouth communication. Reliance on this sort of easily obtained information appears to be common in circumstances ranging from consumers choosing restaurants or auto mechanics to business managers evaluating alternative organizational structures. This paper studies two related environments in arguing that individuals' reliance on word-of-mouth communication has interesting implications for their aggregate behavior. First, motivated by the diffusion of new technologies, we consider a choice between two competing products with unequal qualities or payoffs, and show that the structure of communication is important in determining whether the population as a whole is likely to learn to use the superior product. Second, we consider a choice between two products or practices that are equally good, and ask whether consumers are likely to herd onto a single choice, or whether diversity will obtain even in the long run. We explore the implications of word-of-mouth communication in a simple nonstrategic environment. There is a large population of identical players, each of whom repeatedly chooses between two possible actions. Each player's payoff is determined by his own