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Microeconomics · Hard · 30 marks

IEO past paper: 2023 International Economics Olympiad, open questions

Open Question 2. Competition, Innovation, Inflation This question has three independent parts.

(a)In their 2005 paper (Aghion, P., Bloom, N., Blundell, R., Griffith, R. and Howitt, P., "Competition and innovation: An inverted-U relationship", The Quarterly Journal of Economics 120(2), 2005, 701-728), Philippe Aghion, Nick Bloom, Richard Blundell, Rachel Griffith, and Peter Howitt found the inverted-U empirical relationship between the level of competition and the level of innovation in various industries. That is, not much innovation is seen in very competitive industries as well as in highly concentrated industries; most patents are acquired by firms in moderately competitive industries. Explain why this may be the case.[10](b)One of the ways to regulate non-perfectly competitive markets and reduce their detrimental impact on social welfare is a price cap. In a standard model, the government sets the maximum price at the level where it would be in perfect competition (P = MC), so the firm(s) produce the socially efficient level of output. In some cases, however, this policy is not feasible, because it forces the firm(s) to leave the market, harming society even more. Provide an example of such a market where forcing P = MC is clearly not the best idea and explain why. Suggest another way of regulation that can help achieve the goal instead of (or in addition to) the price cap.[10](c)In macroeconomics textbooks, the authors often distinguish between two types of inflation: cost-push and demand-pull. Assume that two equivalent countries are in the long-run macroeconomic equilibrium, and they simultaneously experience inflation: cost-push in country A and demand-pull in country B. Using the AD-AS model, explain for which country's government (central bank) it will be relatively harder to fight this inflation.[10]

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