Group Formation with Network Constraints

In this paper, I illustrate the importance of both dynamics and network constraints in the group formation process. I introduce a class of games called sequential group formation games, in which players make their group membership decisions sequentially over time, and show that the dynamics act as an equilibrium refinement. However, the resulting equilibrium is highly suboptimal–groups tend to be much too large, relative to the social optimum. I then introduce a network constraint, which limits a player’s action set to those groups that she is connected to on an exogenous network. The network constraint mitigates the tendency for groups to get too large and social welfare is higher when the network is sparse and highly ordered. This result has the surprising implication that informational, institutional, and geographic barriers to group membership may actually improve social welfare by restricting groups from becoming too large.