Final answer:
The network effect is the phenomenon where the demand for a product increases because more people are using it, different from the substitution effect which occurs when consumers replace costlier goods with cheaper substitutes, and the income effect which affects purchasing power.
Step-by-step explanation:
The network effect takes place when the value of a product or service increases as more people use it, driving up demand. This phenomenon is particularly evident in the digital economy, where platforms such as social media sites, messaging apps, and some software products become more valuable as more users join. For example, a social media platform becomes significantly more valuable when a large number of a person's friends are using it, as this increases opportunities for interaction. The network effect can create a positive feedback loop, where increased usage attracts more users, which in turn increases usage further.
The term differs from both the substitution effect, which describes how consumers will turn to substitute goods as prices rise, and the income effect, which deals with how price changes affect consumer purchasing power. Both of these are important for understanding consumer behavior in reaction to changing prices but do not directly describe the phenomenon of increased demand due to higher product usage.