Preliminary Version Do Online Social Networks Increase Welfare ? ∗

We consider a setting where agents select among competing products of unknown quality by costly sequential search. The agents are active on an online social network, and late movers benefit from possibly being able to see early movers’ purchase decisions. In this setting we consider the impact of advertising by firms, and the incentives of the underlying social network platform. We consider display advertising, which is standard firm to consumer advertising, and social advertising, in which agents who purchased that firm’s product are highlighted to their friends. We show that in equilibrium, the heterogeneous firms spend the same amount on advertising. Social advertising is more lucrative than standard banner advertising. However, both forms of advertising have no effect on consumer welfare, and are instead a transfer from the firms to the social network. A social network motivated by advertising revenues may limit the amount of information agents see about actions by other agents, since this will increase advertising revenue. This reduces consumer welfare relative to the first best, since early movers’ purchases are informative about relative quality.