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(1998) Guns, Violence and the Efficiency of Illegal Markets

(1998) Guns, Violence and the Efficiency of Illegal Markets

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Guns,Violence,andtheEfficiencyofIllegalMarkets
STOR
®
JohnJ.DonohueIII;StevenD.Levitt
TheAmericanEconomicReview,
Vol.88,No.2,PapersandProceedingsoftheHundredandTenthAnnualMeetingoftheAmericanEconomicAssociation(May,1998),463-467.
StableURL:http://links.jstor.org/sici?sici=0002-8282%28199805%2988%3A2%3C463%3AGVATEO%3E2.0.CO%3B2-P
TheAmericanEconomicReview
iscurrentlypublishedbyAmericanEconomicAssociation.YouruseoftheJSTORarchiveindicatesyouracceptanceofJSTOR'sTermsandConditionsofUse,availableathttp://www.jstor.org/aboutiterms.html.JSTOR'sTermsandConditionsofUseprovides,inpart,thatunlessyouhaveobtainedpriorpermission,youmaynotdownloadanentireissueofajournalormultiplecopiesofarticles,andyoumayusecontentintheJSTORarchiveonlyforyourpersonal,non-commercialuse.Pleasecontactthepublisherregardinganyfurtheruseofthiswork.Publishercontactinformationmaybeobtainedathttp://www.jstor.org/journals/aea.html.EachcopyofanypartofaJSTORtransmissionmustcontainthesamecopyrightnoticethatappearsonthescreenorprintedpageofsuchtransmission.JSTORisanindependentnot-for-profitorganizationdedicatedtocreatingandpreservingadigitalarchiveofscholarlyjournals.FormoreinformationregardingJSTOR,pleasecontactsupport@jstor.org.http://www.jstor.org/FriJul112:27:402005
 
Guns,Violence,andtheEfficiencyofIllegalMarkets
By
JOHNJ.DONOHUE
III
ANDSTEVEND.LEVITT*
Ineconomics,thestandardmechanismforallocatingscarceresourcesisthemarket.Asmoothlyfunctioningmarket,however,isbuiltuponlegallyenforceablecontractsandpropertyrights.Intheabsenceoflaw,itislikelythatviolence(orthethreatthereof),ratherthanprices,isthemeansbywhichre-sourceswillbeallocated.Interactionsamonganimalsprovideclearevidenceforthisclaim.Dominancehierarchiesbasedonfightingabil-ity,alsosometimesknownaspeckingorders,havebeendocumentedacrossawidevarietyofspecies(e.g.,primates,chickensandotherbirds,reptiles,lobsters)andabroadrangeofresourcesincludingfood,nestingsites,andac-cesstomates(WarderC.Allee,1938;JohnAlcock,1993).Evidencesuggeststhatvio-lencealsoplaysacriticalroleinhumaninter-actionswhenpropertyrightsarenotlegallyenforceable(e.g.,drugdealingandextortion)(seee.g.,PeterReuter,1983;GeoffreyCanada,1995).Inthispaper,weanalyzethedeterminantsoftheefficiencywithwhichillegalmarketsallocatescarceresources.Wedevelopastyl-izedmodelinwhichplayerscompeteforafixedprize,withthewinnerdeterminedbyfightingability.Efficiencyinthiscontextisdeterminedbytheamountofresourcesspentonfighting.Twofactorsaffectingefficiencyemergefromthemodel:
lethality
and
predict-ability.
Perhapssurprisingly,theuseofmorelethalmechanismsforresolvingdisputesdoesnothaveaclearimpactonthesocialcostsofviolence.Theintuitionunderlyingthisresultisthat,asthecostsoflosingafightrise,the
*
Donohue:StanfordLawSchool,CrownQuadrangle,Stanford,CA94305-8610;Levitt:DepartmentofEco-nomics,UniversityofChicago,1126East59thStreet,Chicago,IL60637,andtheAmericanBarFoundation.WethankSusanAlberts,EdwardGlaeser,TimGroseclose,BruceKobayashi,JohnLott,SherwinRosen,ChrisSnyder,andespeciallyJamesHeckmanforinsightfulcommentsandsuggestions.FinancialsupportoftheNa-tionalScienceFoundationisgratefullyacknowledged.
willingnesstofightfalls.Weshowthathold-ingotherfactorsconstant,theresourcesspentonfightingarelowestwhenthecostoflosingiseitherveryloworveryhigh(e.g.,nucleardeterrence),butoverawiderangeoflethalitylevels,theoverallsocialcostsoffightingarefairlystable.Incontrast,thecostsofviolencearecriti-callylinkedtothepredictabilityofdisputeout-comes(i.e.thecertaintywithwhichpotentialcombatantsknowwhowillbevictorious
exante).
Whentheoutcomeofaconflictishighlycorrelatedwithobservablecharacteris-ticssuchasstrengthorsize,thereislittleneedtoactuallyfight.Thusunpredictability,allelseequal,increasestheexpectedpayofftofight-ingforthelower-rankedmember,leadingtomoreconflicts.
I.TheFormalModel
Inthissectionweformalizetheintuitionoftheprecedingdiscussionusingasimplemodelthatomitsanumberofpotentiallyimportantconsiderations(e.g.,privateinformationanddynamicreputationeffects).Nonetheless,themodelprovidesareasonablestartingpointforthinkingformallyabouttheissuesathand.Thestructureofthemodel,whichsharesmanycommoncharacteristicswiththetour-namentsliterature(EdwardLazearandSherwinRosen,1981),isasfollows.Therearetwoplayers.'Eachplayer
i
takesexactlyoneaction,
a,,
adecisionaboutwhetherornottofight;thatis,
a,
E
{fight,nofight}.Theplayersarecompetingforasingleprizewhichprovidesapayoff
W
tothewinner.Inorderto
I
Giventhefunctionalformswehaveadopted,themodelreadilyexpandstoaccommodateanyfinitenumberofplayers,althoughclosed-formsolutionsbecomediffi-culttoobtain.Spaceconstraintsprecludeadetailedderi-vationoftheN-playergame,butwepresentsimulationresultsfromsuchmodelslaterinthepaper.Themodelisequallyapplicabletoindividualsorgroupsofindividuals,suchascompetinggangs.463
 
Period
0
Period
I
Period3
AEAPAPERSANDPROCEEDINGSMAY1998
64
Period
2
1----------------------------1----------------------------1----------------------------1
BothplayersPlayers
{8,8J
Payoffslearn
{OI,e
2}
simultaneouslyarerevealedaredeterminedchoosewhetherornottofight
FIGURE
1.
THETIMINGOFTHEGAME
beeligibletowintheprize
W,
aplayermustfight.
If
aplayerfightsandloses,hereceivesapayoff-C
<
O.
Playerswhoelectnottofightreceiveadefaultpayoffnormalizedtozero.Eachplayerischaracterizedbyafightingability
Fi,
where
(1)
F,
=
8
i
+
e.,
Whatwewillhereafterrefertoastheobservablecomponentoffightingability,{8
h
8
2},
iscom-monknowledgetobothplayers;{el'
e2},
ontheotherhand,isunobservable,eventotheplayerhimself(i.e_,player
i
doesnotknow
e,)_
Thisunobservablecomponentcanbethoughtofasrandomnessinfightoutcomes.The8'sareindependentlyandidenticallydistributednormalwithmeanzeroandvarianceequalto
0.5o}
The
s's
areassumedtobeindependentlyandidenticallydistributedwithatype-Iextreme-valuedistribution,
2
characterizedby
(2)
Prje,
os;
e]
=
exp[-exp(-eIO'E)]'Thisdistributionprovestobeextremelytrac-table,aswillbecomeapparent.Visually,thetype-Iextreme-valuefunctionresemblesanormaldistribution,butwithathickrighttail.The
O'~
terminfluencesthedispersionofthedistribution.ThetimingofthegameisasshowninFigure1.
In
period0,theobservablecomponentsoffightingability(the8's)becomecommonknowledge.Basedonthissymmetric(butin-complete)informationonfightingabilities,theplayerssimultaneouslychoosewhetherornottofight.Aftereachplayerdecideswhetherornot
2
ThomasDomencichandDanielMcFadden(1975)re-fertothisdistributionas"Wiebull(extremevalue,Gne-denko)."WethankJamesHeckmanforsuggestingthisfunctionalform.
toenterthefight,theunobservablecomponentsoffightingability{el,
e2}
arerevealed,andthewinnerisdetermined.Thewinneristheplayerwiththehighestvalueof
F,
amongthesetofplayerswhoelectedtofightinperiod1.Ifonlyoneplayerchoosestofight,heautomaticallywinstheprize
W.
Ifneitherplayeroptstofight,noprizeisawarded.
It
isimmediatelyevidentthatequilibriummustinvolveatleastoneplayerchoosingtofight.Forthoseequilibriainvolvingoneplayerchoosingtofightandtheotherelectingnottofight,nofightoccursandtherearenore-sourcesexpendedonfighting."Onlywhenbothplayerselecttofightwillafighttakeplace.Let
Pi
equaltheprobabilitythatplayer
i
winstheprize
W
conditionalonbothplayerschoosingtofight:Ingeneral,thereisnosimplenumericalsolu-tiontotherelationshipinequation(3).
It
hasbeenshown,however,thatiftwoindependentrandomvariableseachhavethesametype-Iextreme-valuedistribution,thentheirdiffer-encehasalogisticdistribution(NormanJohnsonandSamuelKotz,1970;DomencichandMcFadden,1975).
It
isthisresultthatmo-tivatesourearlierdistributionalassumptions.Consequently,
Pi
canbeexpressedas
(4)
Given
Pi'
player
i
choosestofightifandonlyiftheexpectedpayofftofightingis
'Whichofthetwoplayerschoosestofightinsuchequilibriawilldependnotonlyontheparametersofthemodel.butalsoonplayerbeliefs.Equilibriainvolvingbothplayersfighting(ourprimaryfocus)willnotdependonplayerbeliefs.

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