The Economic Theory of Illegal Goods: The Case of Drugs

Topics: Supply and demand, Illegal drug trade, Price elasticity of demand Pages: 30 (8355 words) Published: December 30, 2013

Gary S. Becker
Kevin M. Murphy
Michael Grossman
Working Paper 10976
1050 Massachusetts Avenue
Cambridge, MA 02138
December 2004

The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
© 2004 by Gary S. Becker, Kevin M. Murphy, and Michael Grossman. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

The Economic Theory of Illegal Goods: the Case of Drugs
Gary S. Becker, Kevin M. Murphy, and Michael Grossman
NBER Working Paper No. 10976
December 2004
JEL No. D00, D11, D60, I11, I18
This paper concentrates on both the positive and normative effects of punishments that enforce laws to make production and consumption of particular goods illegal, with illegal drugs as the main example. Optimal public expenditures on apprehension and conviction of illegal suppliers obviously depend on the extent of the difference between the social and private value of consumption of illegal goods, but they also depend crucially on the elasticity of demand for these goods. In particular, when demand is inelastic, it does not pay to enforce any prohibition unless the social value is negative and not merely less than the private value. We also compare outputs and prices when a good is legal and taxed with outputs and prices when the good is illegal. We show that a monetary tax on a legal good could cause a greater reduction in output and increase in price than would optimal enforcement, even recognizing that producers may want to go underground to try to avoid a monetary tax. This means that fighting a war on drugs by legalizing drug use and taxing consumption may be more effective than continuing to prohibit the legal use of drugs.

Gary S. Becker
Department of Economics
University of Chicago
1126 East 59th Street
Chicago, IL 60637
Kevin M. Murphy
Graduate School of Business
University of Chicago
Chicago, IL 60637
and NBER

Michael Grossman
365 Fifth Avenue
New York, NY 10016
and CUNY Graduate Center

1. Introduction
The effects of excise taxes on prices and outputs have been extensively studied. An equally large literature discusses the normative effects of these taxes measured by their effects on consumer and producer surplus. However, the emphasis has been on monetary excise taxes, while non-monetary taxes in the form of criminal and other punishments for illegal production of different goods have been discussed only a little (important exceptions are MacCoun and Reuter, 2001 and Miron, 2001).

This paper concentrates on both the positive and normative effects of punishments that enforce laws to make production and consumption of particular goods illegal. We use the supply and demand for illegal drugs as our main example, a topic of considerable interest in its own right, although our general analysis applies to the underground economy, prostitution, restrictions on sales of various goods to minors, and other illegal activities. Drugs are a particularly timely example not only because they attract lots of attention, but also because every U.S. president since Richard Nixon has fought this war with police, the FBI, the CIA, the military, a federal agency (the DEA), and military and police forces of other nations. Despite the wide scope of these efforts–and major additional efforts in other nations–no president or drug “czar” has claimed victory, nor is a victory in sight. Why has the War on Drugs been so difficult to win? How can international drug traffickers command the resources to corrupt some governments, and thwart the extensive efforts of...

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