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Economics of Illegal Drugs
Molly Burke, Usman Chaudhry, Peter Hathotuwa, Jackson
Partin and Chris Voltz
Some Negative Effects of Drug
Prohibition in the USA
• Government expenditures on active
prohibition law enforcement total an
estimated $7.7 billion annually ($5.1 billion
accrued to state and local government; $2.6
billion at the federal level.
• Inability to capitalize on potential tax revenue
of $2.9 billion annually with a corporate tax
rate of 2.1% ($6.1 billion with a sin tax rate of
Government Expenditure on
Marijuana Prohibition (2000 est.)
• Prohibiting marijuana use incurs a twofold
economic burden on the government:
– Combined costs of arresting suspected drug offenders,
prosecuting them in court, and incarcerating them
once convicted
– Inability to tax drugs due to prohibition
• If marijuana were legalized, expenditure on law
enforcement would diminish and the gov’t could
generate revenue through taxation
• Total Federal expenditure--$2.6 billion
Government expenditure on
Marijuana Prohibition (2000 est.)
• State and local government expenditure
occurs via three major branches:
– Police Budget: Arrests for possession and
sale/manufacture--$1.71 billion
– Judicial and Legal Budget: Prosecutions--$2.94
– Corrections Budget: Incarceration of marijuana
prisoners--$484 million
• Total State and Local expenditure : $5.1 billion
• The government could legalize drugs and institute taxation
like those on alcohol and tobacco
• The current estimated US expenditure on illegal marijuana
is around $10.5 billion annually
• Assuming relatively inelastic demand for marijuana and a
minimal price decline (25%) after legalization, we can
assume an expenditure of around $7.9 billion annually
• Taxation of this expenditure could generate between $2.4$9.5 billion annually
• A sin tax, like those placed on alcohol and tobacco sales,
could have economic and moral benefit:
– Generate massive revenue, while
– Keeping consumption lower than it would be without a tax
Normal excise tax
• Assume tax as fraction of
price= 30%
• $2.4 billion in tax revenue
• Possible reduction in
revenue due to continued
home production of
Sin tax
• Assume tax as fraction of
price =80%
• $9.5 billion in tax revenue
• Possible reduction in
revenue due to elastic
demand (decline in
consumption); underground
market activity to avoid high
Prohibition vs. Monopolistic
• Marijuana is currently a demerit good
• Due to illegality of manufacture, sale, and
consumption, suppliers face high risks, including arrest
and imprisonment. This affects supply and demand:
 Price of the drug increases. Many consumers are willing
to pay a higher price to cover the “risk premium” of
getting caught buying or receiving subpar goods.
 Quantity demanded decreases (by the Law of Demand).
Some would-be consumers of the drug choose not to enter
the market due to fear of prosecution or the high cost of
the drug due to the risk premium
 Upward shift in supply (supply decreases)
 Consumer surplus and producer surplus decrease
In Monopolistic Competition
• With legalization, the drug market could satisfy a
monopolistically competitive model
• Monopolistic competition means:
– Many sellers (more sellers willing to enter the market
once fear of prosecution is eliminated)
– Differentiated products (not all weed is created equal)
– Multiple dimensions of competition (sellers can now
– No significant barriers to entry (no longer illegal)
Counterintuitive Aspects
• The drug market and its supply and demand curves
differ from those of most other products
• Traditionally, the magnitude of changes is
acknowledged to depend on the elasticity of demand
or supply
– However: their direction is not questioned except that the
extreme case of perfectly inelastic demand is sometimes
considered on the ground that drugs are addictive
• Many atypical responses possible with each externality
• Focus:
– Demand-control interventions (prevention & treatment)
– Atypical relationship of price to supply for producers
Demand-control Interventions
• Ineffective rehabilitation programs perceived
as demand-limiting factor
– Due to labeling of participants as heavy users, can
lead to more intensive drug use
– Counterintuitive because rehab can result in
greater consumption after course of treatment.
• The fault lies with individual programs, not the concept,
but treatment does not always result in decreased
Demand-control Interventions
• Immunotherapy
– Antibodies created by immunotherapy are too large to cross
the blood-brain barrier. Instead they bind with the drug
molecule in the blood stream.
• This prevents bound molecules of the drug from reaching the brain.
– Difficult to quantify, but ingesting a given amount of the drug
after immunotherapy produces a “smaller” psychic effect
since less reaches the user’s brain. Conversely, users would
have to spend more to achieve the “same” effect as before.
• Some patients who try cocaine after immunotherapy vaccine
describe not getting the rush but still experiencing similar effects on
their heart.
– Can increase drug consumption rather than decrease,
depending on user attitude. (Cost vs. Benefit changes)
• Less harm to individual, but less overall welfare since demand
increases. More supply = larger drug organization = more crime
Atypical relationship of price to supply
• In countries like Afghanistan, there is a lack of
– No banks to serve opium farmers. Credit is therefore very
expensive, and saving must occur in other ways.
• As a result, holding opium (relatively compact and nonperishable) is a common method of saving from season
to season.
– In good times, opium farmers may hold back some of a
year’s production from the market to save for a rainy day
(aka drought).
• When prices rise above a certain level, therefore,
gradient of the supply curve changes significantly.
– Supply ceases to increase with price, defying traditional
economic model.
Spatial Economics and Drugs
• Vertical
– Quality of drug, how product is cut
• New drug dealer vs. Established
• Price tends to be less variable - variable is quality of drug
• Horizontal
– Dealer territories, networks of sellers
• Complex, multilayered networks so that raids do not lead
back to organizer/importer/producer
• Standard aspects of spatial economics do apply in terms of
distribution of territory among competitors, since dealers
want to maximize sales
Drug Enforcement Administration
• Goal: To enforce controlled substance laws,
bring civil and criminal justice to those
manufacturing and/or distributing controlled
substance, and work to reduce the availability
of illicit substances in the United States and
• Budget for FY 2011 was $2.02 Billion
• Between 2005-2011 the DEA took $17.7
Billion for drug trafficking organizations
10,000 Men and Women
5,000 Special Agents
500 Diversion Investigators
800 Intelligence Research Specialists
300 Chemists
Arrests and Seizures
Number of DEA Arrests
• Federal and State governments: $373.9 Billion
– 95.6% was spent to deal with the consequences
and aftermath of drug abuse and addiction
– 1.9% spent on prevention and treatment
– 1.4% on taxes and regulations
– $1.7 Billion has been requested for 2012 to be
used in outreach and education programs
– SAMHSA found the average cost for addiction
rehab in 2002 was about $1,500 per course of
– The same study found that 23 million people
needed treatment but only about 2.3 million
people actually get treated
• The cost is raised substantial depending on the drug
and treatment facilities
Marijuana Use Nationally
• 28.5 million Americans age 12 and older say they used
marijuana in 2009 (National Survey on Drug use and Health
• value of US-grown marijuana industry: $20-$50 billion
• value of US corn industry: $15-$30 billion
Impact of Criminalization
• law enforcement: $2.1 billion (2001)
• imprisonment: around $960 million per year
Current Decriminalization
• California: average price of an ounce of
marijuana is $322
• in states where marijuana is not
decriminalized average cost of an ounce is
over $400
Impact on Producers/Consumers
• average cost of 0.5 gram of marijuana sold on
street is around $9
• cost of producing same amount is only $2
Impact on Other Markets
• Tobacco paraphernalia
• Alcohol
Have you ever taken an Economics course?
What is your average monthly demand?
What is your selling price? Is that the market price?
What is your average monthly cost?
What is your average monthly profit?
What do you do if your demand exceeds your supply?
What do you do if your supply exceeds your demand?
What is the opportunity cost of your business?
Do you think there is competition? What do you think would
happen if there is competition?
• Does the price changes with quality?
How does the price structure work?
What are the variables in your business?
What do you think is the social cost of your business?
Do you sell the same type or different types?
How do you reach out to customers?
What is the impact of joining a fraternity on your business?
Have you considered diversification? Aderall, Molly, Cocaine?
Are there any chances of loss in your business? What are
these chances?
• What do you think is the impact of all the ‘middlemen’ in drug
Facts about Drug-Dealing
• The average estimated earnings of the drug gang leaders
are between $50,000 to $130,000 annually.
• The estimated earnings of the second level members of
these gangs are about $12,000 annually.
• The average estimated earnings of the street level
dealers are less than $2,500 annually despite the fact
that they work 20 hours per week.
• Drug dealing is done on part-time basis. Survey of drug
dealers in Washington DC shows that about 25% of the
study group sold drugs no more than once a week and
earned about $50 per month from this.
Facts about Drug Dealing
• Three-eighths of the study group sold drugs on daily
basis and reported a median net income of $2,000 per
• Drug dealing is a “transitory enterprise”. About 75% to
80% of the street level drug dealers held low paying jobs
in the legitimate sector.
• Arrest data of Washington DC shows that 74% of the
people arrested for the possession of drugs were
employed and about 67% of people charged with drug
dealing were employed.
Facts about Drug Dealing
• Most of the street level drug dealers engage in this
business to supplement their income from the low
paying jobs.
• The authors of the Washington DC study have concluded
that most members of these gangs are not engaged in
violence. Only a quarter of these members have been
arrested for violent crimes and about one-sixth have
been convicted of violent crimes.
• Violence causes disruption and businesses (legal or
illegal) do not like disruptions.
All the graphs and the tables are taken from the ‘World Drug Report 2011’ of the
United Nations Office on Drugs and Crime.