More Slides from Ed Dolan’s
Econ Blog http://dolanecon.blogspot.com/ Econ 101, Hayek, and Why We are Losing the War against Drugs Posted March 30, 2011 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics , from BVT Publishers.

The Drug Wars Spread <ul><li>After
shaking the economic and political structures of Mexico and Columbia, the drug wars are moving to Central America </li></ul><ul><li>Where to look for clues to why the United States is losing its endless war on drugs </li></ul><ul><ul><li>Econ 101 and demand elasticity </li></ul></ul><ul><ul><li>The writings of Friedrich Hayek </li></ul></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com Photo sources: http://upload.wikimedia.org/wikipedia/commons/6/67/Cocaine3.jpg ; http://commons.wikimedia.org/wiki/File:Topographic_map_of_Central_America.jpg

Elasticity of Demand <ul><li>Price elasticity
of demand means the percentage change in quantity of a good demanded that is associated with a one percent change in price </li></ul><ul><li>If the percentage change in quantity is greater than the percentage change in price, demand is elastic </li></ul><ul><li>If the percentage change in quantity is less than the percentage change in price, demand is inelastic </li></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Revenue and Price when Demand
is Elastic <ul><li>When demand is elastic, a decrease in price will produce an increase in revenue </li></ul><ul><li>Example: </li></ul><ul><ul><li>100 units are sold at a price of $100 for revenue of $10,000 </li></ul></ul><ul><ul><li>If price is cut to $90, 120 units are sold for reveue of $10,800 </li></ul></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Revenue and Price when Demand
is Inelastic <ul><li>When demand is elastic, a decrease in price will produce an increase in revenue </li></ul><ul><li>Example: </li></ul><ul><ul><li>100 units are sold at a price of $100 for revenue of $10,000 </li></ul></ul><ul><ul><li>If price is cut to $90, 120 units are sold for reveue of $10,800 </li></ul></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Elasticity of Demand for Cocaine
<ul><li>Data on demand for illegal drugs is limited because of the nature of the market </li></ul><ul><li>However, some studies have been done. They suggest that demand for cocaine is inelastic </li></ul><ul><li>One survey of the literature* found estimates of demand elasticity ranging from -.51 to -.73, indicating that a 1% increase in price reduces quantity sold by less than 1% </li></ul><ul><li>Accordingly, revenue from sale of cocaine would tend to increase when the price increases </li></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com *Link for elasticity estimates : http://www.nap.edu/openbook.php?record_id=9441&page=30

Implication of Inelastic Demand for
Policy <ul><li>The main strategy in the war on drugs is interdiction of supply, which tends to shift the supply curve upward and to the left </li></ul><ul><li>With inelastic demand, we expect interdiction to lead to an increase in revenue for drug cartels </li></ul><ul><li>More revenue may not mean more profit, because costs increase </li></ul><ul><li>However, more revenue means more money to spend on hiring thugs and corrupting politicians </li></ul><ul><li>In that sense, interdiction is a self-defeating strategy that increases, rather than decreases, corruption and drug violence </li></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

Cocaine and Heroin Prices Have
Fallen Over Time <ul><li>Despite efforts to reduce supply, prices of cocaine and heroin have fallen over time </li></ul><ul><li>Possible explanation: Drug cartels have invested in capital and technology like drug-smuggling submarines that have reduced costs over time despite interdiction efforts </li></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com Follow this link to view the original graph from which this one was derived

Organizational Effects of Interdiction Policy
<ul><li>Drug cartels in some respects act like normal businesses </li></ul><ul><ul><li>Prices affect demand for the product according to elasticity </li></ul></ul><ul><ul><li>Part of revenue is reinvested in technologies to improve delivery and reduce costs </li></ul></ul><ul><li>In other ways they are different </li></ul><ul><ul><li>They recruit people who are not inhibited by laws or morals </li></ul></ul><ul><ul><li>They use far more violence in pursuit of profits </li></ul></ul><ul><li>The results resemble the structure of totalitarian organizations as described by Friedrich Hayek </li></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com Yet while there is little that is likely to induce men who are good by our standards to aspire to leading positions in a [drug cartel], and much to deter them, there will be special opportunities for the ruthless and unscrupulous. There will be jobs to be done about the badness of which taken by themselves nobody has any doubt . . . [as a result] the readiness to do bad things becomes a path to promotion and power. Friedrich Hayek, The Road to Serfdom Words “drug cartel” have been substituted for “totalitarian organization” used in original Hayek Photo courtesy of Mises Institute http://upload.wikimedia.org/wikipedia/commons/7/7f/Friedrich_Hayek_portrait.jpg

The Bottom Line: Why We
are Losing the War on Drugs <ul><li>As long as demand is inelastic, efforts to restrict supply have the unintended consequence of increasing revenue for drug cartels </li></ul><ul><li>Increased revenues are invested in hiring thugs, corrupting politicians, and new delivery technology </li></ul><ul><li>Illegal organizations attract violent, immoral people who use violent, immoral business practices </li></ul><ul><li>In these respects, the war against drugs creates the conditions for its own failure </li></ul>Posted March 30, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com