Strategic Random Networks and Tipping Points in Social Institutions∗

This paper develops strategic foundations for a statistical model of random networks with heterogeneous expected degrees. Based on this, we show how institutional or technological changes that subtly alter the costs and indirect benefits of relationships can cause large changes in behavior and welfare. In the model, agents who value friends and friends of friends choose a level of social activity, which increases the probabilities of links but is costly. There is a sharp transition from fragmented, sparse equilibrium networks to connected, dense ones when the value of friends of friends crosses a costdependent threshold. This transition mitigates an extreme inefficiency.