Social Learning with Endogenous Information and the Countervailing Effects of Homophily

Abstract

People learn about opportunities and actions by observing the experiences of their friends. We model how homophily -- the tendency to associate with similar others -- affects both the endogenous quality and diversity of the information accessible to decision makers. Homophily provides higher-quality information, since observing the payoffs of another person is more informative the more similar that person is to the decision maker. However, homophily can lead people to take actions that generate less information. We show how network connectivity influences the tradeoff between the endogenous quantity and quality of information. Although homophily hampers learning in sparse networks, it enhances learning in sufficiently dense networks.