The Network effect is a term that describes technologies or trends that become more valuable as more people uses them. There are, of course, very recent examples of this like Facebook or Twitter, but there is also sort of a joke going around.
Remember the Fax machine? The joke goes that the first person to buy a Fax machine was an idiot, and the second one just wanted to send a document. It rings like truth at least.
As more and more people got Fax machines, prices went down as a result of economies of scale, cheaper technologies, etc., but the value of having a Fax machine also went up in the minds of many, because now "everybody" had one, and it was possible to send them documents. So there was a point where the perceived value and the price met, and people like me, also jumped in and bought one.
The network effect is modeled (notice that I say modeled, not governed) by Metcalfe's law, originally born in the Telecommunications industry, which touts that the value of a network is proportional to the square of the number of nodes (or members) connected, and it is derived simply from how many unique 1-1 connections can be established. For the Fax machine example, one fax has zero connections, two faxes can establish exactly one connection, three can do three, four can connect in six different ways, five in ten, and so on. So the actual mathematical expression is a bit more complex n(n-1)/2, but for practical purposes and because we are using the word proportional, and not equal, it comes down to n2.
And the word proportional is very important, since the actual value will depend on the specific value that every user puts on an individual interaction as well. Going back to the Fax machine example, if we are faxing exclusively multi-million dollar contracts, the value of the network will be huge, but if the only thing circulating are chain letters, then it becomes very low. Modern networks also allow for all kinds of variations on the 1-1 connection. It is possible to create groups, and other ways of connection, but the principle is the same.
In any case, the value of connections is very difficult to hold in our linear minds, and when you are building something, by all means look for the network effect and how to leverage it.
Which reminds me, you have to send this blog post to ten of your closest friends, and on the seventh day you'll be blessed with unexpected riches, but if you don't….