Economic growth and economic development 598

Introduction to Modern Economic Growth
given to final good producers would also be useful in increasing the growth
rate.
Moreover, it is noteworthy that as in the first-generation endogenous growth
models, a variety of different policy interventions, including taxes on investment
income and subsidies of various forms, will have growth effects not just level effects
in this framework (see, for example, Exercise 13.11).
Naturally, once we start thinking of policy in order to close the gap between the
decentralized equilibrium and the Pareto optimal allocation, we also have to think of
the objectives of policymakers and this brings us to political economy issues, which
are the subject matter of Part 8. For that reason, we will not go into a detailed
discussion of optimal policy (leaving some of this to you in Exercises 13.10-13.12).
Nevertheless, it is useful to briefly discuss the role of competition policy in models
of endogenous technological progress.
Recall that the optimal price that the monopolist charges for machines is
χ=

ψ
.
1−β

Imagine, instead, that a fringe of competitive firms can copy the innovation of any
monopolist, but they will not be able to produce at the same level of costs (because
the inventor has more know-how). In particular, as in the previous chapter, suppose
that instead of a marginal cost ψ, they will have marginal cost of γψ with γ > 1. If
γ > 1/ (1 − β), this fringe is not a threat to the monopolist, since the monopolist
could set its ideal, profit maximizing, markup and the fringe would not be able to

enter without making losses. However, if γ < 1/ (1 − β), the fringe would prevent

the monopolist from setting its ideal monopoly price. In particular, in this case the

monopolist would be forced to set a “limit price”, exactly equal to
(13.23)

χ = γψ.

This price formula follows immediately by noting that, if the price of the monopolist were higher than this, the fringe could undercut and make profits, since their
marginal cost is equal to γψ. If it were below this, the monopolist could further
increase its price without losing any customers to the fringe and make more profits.
Thus, there is a unique equilibrium price given by (13.23).
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