Abstract

This report is to understand the drug market in an analytical perspective as to consider

how demand and supply affect the usage and prices of drugs. The approach to
understand the characteristics of real world drug markets is essential now days in
research topics. We are aiming to give a summary of certain facts about illegal drug markets
and the role of enforcement in affecting the price of drugs and the way they are distributed.

Introduction
The way economics work in illegal drugs is the same as other illegal goods. Actually,
illegal drugs are treated like immigrant labors, prostitution as well as selling body parts
such as kidneys. Producers in black market can gain huge profits by limiting
competition and enforcing restrictions. The war against illegal drugs started in 1971 by
President Nixon. However, the purchases of them are incredibly increasing reaching
$150 billion worth of heroin, marijuana, and cocaine a year. Morally, it does make sense
to prohibit dangerous drugs since they are destroying the entire life of an addict as it
also can affect the entire community however, in an economic perspective, the war is not
as convincing since some groups of economists are actually against the idea of
prohibition illegal drugs. Their argument is based on taxation and the money
governments may obtain from them. Now we need to answer an important question,
why the prices are high?
Heroin and cocaine are harvested the same way the case in the coffee market, but the
enforcement of their illegal status has the effect of raising the price. The selling price of
heroin is 30 times higher per unit mass than gold. Prices are high because heroin and
cocaine are short in supply. High demand is also a reason as well as suppliers have the
upper hand in negotiations in price in economy it is called ‘bargaining power’ in the
trade of illegal drug dealers have negotiating power over buyers at all market levels also,
he prices of illegal drugs surges the closer it gets to the end customer. researchers
suggested that the number of links in the chain between importation and retail level
distribution can be short and the market is understood as a flat pyramid. The number of
links can be huge and that must affect the ending price significantly. For a 10 kilogram
of heroin this could mean transactions take place between five dealers before the drug
reaches the end user. How prices, profits and business costs alter at successive market
levels is a significant gap in our understanding of illegal drugs markets. Recent research
has used data obtained from interviews with traffickers to construct supply chains for
heroin and cocaine in the UK. Figure A suggest that the overall mark-ups for heroin and
cocaine between the farms and the consumer are about % 16,800 and % 15,800
respectively. These can be compared with the mark-up for coffee between the farms and
sale in retail markets in the consuming country by % 413. Figure A shows that the mark-
ups associated with dealing heroin and cocaine are greatest at different points in the
supply chain. Greater markups suggest greater costs and risks to the dealer. The
markups associated with importing cocaine into the UK are greater than those
associated with importing heroin, while the mark-ups associated with selling heroin at
street level are greater than for dealing cocaine. In comparison with coffee, the markups
in the consuming country are similar. Prices vary by time and geographic location.
Economics suggests that prices vary because of changes in the relationship between
supply and demand.

Supply and Demand

First, we need to introduce the supply and demand concepts which provide the basic
economic protocol of drug policy. Unfortunately, the old economic protocol has many
limitations to understand illegal drug markets. In addition, there are important
parameters which are difficult to observe such as addiction (prices will differ) and
increase search time (consumers will need more time to find information about the
dug). However, the old supply and demand protocol gives a specific results to define
certain pathways of public policies. For example, we can interpret data in known
quantities and prices of illegal substances in certain drug markets. It also focuses on the
sensitivity of supply and demand related to prices as well as the production technologies
and prices. From figure 2-1, curve D1 goes down at higher prices which means people
are having lower quantities which can be translated into two things: some drug users
decrease their consumption while others can possibly stop using the drug. But in lower
prices, addiction may give asymmetry and increase participation. Supply curve S1 goes
up at higher prices therefore the supplier can produce more drugs to the market which
means either current produces may expand their businesses or new companies will open
up and produce new source of production (supply). On the other hand, increase police
actions against street dealers causes the market supply curve to go up, or to the left to
S2. The distance between S1 and S2 shows the increase in unit production and
distribution costs resulted by supply side interventions.
The old model assumes the market price adjusts until an equilibrium is reached so the
quantity demanded equals the quantity supplied. In E1= Q1, P1. A new equilibrium is
reached after the supply side intervention which is E2=Q2, P2 which shows an
interaction of both demand and supply factors. The slopes associated with these curves
determine that rising production costs are borne by consumers in the form of higher
prices. The supply and demand model tells us that the supply side intervention in the
model should produce higher drug prices but in the new drug market equilibrium E2,
the drug price is higher P2> P1, as the price of drugs purchased Q2 is lower <Q1.

FIGURE 2-1 Impact of a supply-side enforcement with a steep demand curve.

In the supply-side intervention resulting in a small increase in the market price to P2’.
In this situation, the war on drugs has worked quite so well by reducing the quantity of
drugs consumed to Q2’. However, because drug demand is so responsive to the higher
prices caused by the intervention, the price does not have to increase much to bring us
back to equilibrium. In contrast, the sharp increase in price seen is accompanied by a
smaller reduction in the quantity of drugs consumed the war on drugs did not work that
well. In conclusion, the comparison between Figures and shows that it is important not
to confuse the market price with reducing drug use.

FIGURE 2-2 Impact of a supply-side enforcement with a flat demand curve.

Demand shifters, which are agencies such as anti-drug media organizations or
treatment programs who measure that target users, demographic factors and changing
attitudes toward intoxication, self-control, as well as income and employment
opportunities. Drug demand is known as price detection, and changes in these other
influences may be important explanations for the perceived differences in drug markets
over time and in all parts of the world. Demand-side policies seek to turn the demand
curve downwards (left). Everything else is equal, such policies shift the balance down
the supply chain, resulting in lower prices and lower prices for drugs used. If the social
harm associated with illicit drug use is positively related to the dollars spent on these
items (as this is a criminal offense), demand-based interventions are more attractive
because they result in better prices and results, while supply-only interventions produce
only positive results.
FIGURE 2-3 Drug supply and demand with simultaneous shifts in demand and supply
curves.
Demand shifting can also hide the impact of supply-side interventions shows a situation
in which a supply-side Intervention was launched about the same time as a non-price
influence shifted the demand curve out (up and to the right). The increase in the
population cohort size of adolescents and young adults is an example of demand
influence. Research was done in 2004 found that marijuana prevalence was correlated
with the number of 15-19 years old in the US population. At the new equilibrium, the
quantity of drug use has not changed much because of the offsetting effects of the
supply-side intervention and the demand shift. However, the supply-side intervention
succeeded in preventing drug use from increasing to Q3, which would have been the
result if the demand had shifted in the absence of the intervention. In this case, the price
increase from P1 to P3 is a valid indicator of the success of the supply-side intervention,
even though success is not apparent in changes in the quantity used.

Features of Drug Market

The quality of product
When we buy illegal products, it is impossible to validate the quality before purchase.
Illegal drug consumers also cannot directly verify product quality prior to purchase just
as traveler who stops at a roadside restaurant. Actually, before Amazon eBay and other
websites, costs and quality differences were very important in the market. Unknown
quality differences is greater for illegal drugs because the quality of certain chemical
cannot be evaluated even after consumption. For example, the intensity of a drug
euphoria is mostly affected by the last time used, expectations of the consumer as it was
mentioned in a paper published by Zinberg in 1984.
Cost and Price Factors
In 1998, a report provided detailed information about the value of the elements of costs
of cocaine. It was found that the price of the entire cocaine selling in Colombia equals
%1 percent of the retail price of the drug on the street in the United States. Using some
extra data, dealers’ compensation regarding the risks of deaths, injury, and
incarceration accounted for approximately $21,000 per dealer annually. Therefore,
Supply-side intervention can increase retail drug prices by increasing the risk of custody
and by increasing several other components of costs, such as seizures of drugs.
Kuziemko and Levitt researchers in economy estimate that increases in the certainty
and severity of incarceration between 1985 and 2000 raised cocaine prices by 5-15
percent. The elasticity of price correlated to incarceration rates was low. During that 10-
year period, incarceration for drug law violations increased from 82,000 to 376,000,
about two-thirds of which were cocaine offenders (roughly 200,000). Thus, to achieve
the modest increase in cocaine prices, it cost an extra $6 billion a year just for
incarceration (assuming a cost of $30,000 per year to house an inmate), not including
the costs of apprehension and prosecution. This analysis, though just for one period and
with limited data for example, on actual time served by drug dealers raises questions
about the cost-effectiveness of tough enforcement.
Another aspect, consumers pay an agreed price for a certain quantity of a good of known
quality. In contrast, retail drug markets are characterized by conventional pricing,
where consumers pay $5 or $10 for gold or dime and avoid bargaining about the price.
This is an advantage for illegal purchases, but it can result also in problems since
weights of the gold or even the purity is not surly known. In 2002, the System to
Retrieve Information from Drug Evidence showed the range of price for heroin (less
than one gram) was $280 to $428 at the retail level. Therefore, a buyer had a quarter
probability of paying less than $280 and an equal probability of paying more than $428.
That can cause implications for the behavior of the market. In 2004, Reuter and
Caulkins used a model of the market for lemons which quality cannot be determined by
buyers. Some of the consequences of this uncertainty such as the encouragement of
customers to purchase regularly from more than one seller in order to obtain
information about the quality adjusted price of their first source. For sellers, it allows
limited strategic manipulation of these prices.
The process of buyers search plays an important role as it can have many implications.
For instance, law enforcement may restrict buyers to switch to different suppliers or
compare prices. While if buyers are targeted, it enhances the bargaining of sellers and
may lead to higher prices or reduced quality. In 2006, cocaine and heroin-related
emergency department admissions were tested. The author found an elasticity of the
probability of a cocaine mention with respect to cocaine prices was 0.27 while
corresponding elasticity in the case of heroin was 0.15. He concluded it as an evidence
that heroin and cocaine act as complements in consumption. In addition, he found a
negative lagged price effects, a pattern consistent with either an addiction model or a
cumulative insult model of individual vulnerability to drug-related health concerns. In
2004, the same author reported on illegal drug use detected by urine among prisoners.
The author found short term participation elasticities of approximately 0.17 for cocaine
and 0.09 for heroin, and long-term elasticities approximately twice as large.
Example of Individual Operations
In 2000, a unique analysis of one drug-selling operation was done in Chicago’s selling
areas. The authors describe the nature of Chicago drug selling as gangs and their small
leaders control certain areas where illegal purchases can occur. The author described it
as a tournament compensation system (low level dealers get low wages in return for the
prospect of advancement). High rate of injury and death was also reported in that
particular paper in street dealers which was significantly higher than civilians.
Conclusion
In conclusion, the supply and demand concept represent a unique model to understand
the market of illegal drugs. In this report, our main focus was on the flexibility of the
economic approach to capture many of the characteristics of illegal drug markets. In
addition, we addressed the lacking of certain economic models to fully obtain a
description of illegal drug markets. We also discussed how it is difficult to bring a
relationship between the behavior of users and illegal drug costs which tells us how
much work needed to be done to understand the idea.