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Free response question

Microeconomics · Hard · 30 marks

IEO past paper: 2026 International Economics Olympiad, open questions

Open Question 1. "The Model That Could Not Cross the Border" Frontier AI systems are dual-use technologies: they may help firms improve productivity, but at the same time they may help foreign users discover and exploit vulnerabilities or attempt to replicate some of the model's capabilities or extract sensitive information from it. Country A's firm AlphaAI owns the best AI model and sells monitored access to entities in Country B (one unit = one standardized access contract during the policy period). Country B's inverse demand is $P = 100 - Q$ . AlphaAI's marginal cost is 20 and it is a foreign monopolist in Country B. The government of A believes exports create an expected national-security external cost $E(Q) = 8Q + Q^2/2$ (where $8Q$ captures an ordinary misuse risk, while $Q^2/2$ is due to risks rising disproportionately with scale, e.g. jailbreaks). Country A defines welfare as: AlphaAI profit + government license revenue − external cost.

(a)Suppose exports are unregulated. With unregulated exports, find AlphaAI's profit, the external cost, and Country A's welfare. Is a complete export ban better for Country A compared to unregulated exports? Explain.[8](b)Instead of a ban, suppose Country A requires AlphaAI to buy one export license for every unit of access sold abroad. Find the per-unit license fee that maximizes Country A's welfare. Compare this policy with both unregulated exports and a complete ban on profit, government revenue, welfare, and the external cost.[8](c)Instead, Country A imposes an export quota equal to the quantity found in part (b). Consider two methods of allocating the quota rights: (i) the rights are given to AlphaAI for free; (ii) AlphaAI pays the government, for each unit of quota used, the per-unit fee found in part (b). Under each method, calculate AlphaAI's profit, government revenue, Country A's welfare, and the external cost. Identify which parameters differ between the two methods and which remain unchanged.[4](d)Alternatively AlphaAI sells a copy of the model weights outright to a foreign firm, for a one-time payment of 900. There would be no license revenue afterwards. Country A's government estimates that this sale would create an external cost of 700. Would AlphaAI prefer this to the licensing like in (b)? Would Country A prefer it? Explain.[5](e)After Country A restricts access, Country B builds its own substitute AI model. Give one potential benefit and two potential costs/risks of this response for Country A.[5]

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