Question

Question 4

Most studies suggest that the elasticity of demand for illegal drugs is approximately around 0.5. The US government spends over $50 billion a year arresting over 1.5 million people and deterring the supply of drugs with police, prisons, and border patrols. This is in turn increases the cost of smuggling and dealing drugs. Imagine two possible regimes: a prohibition regime and a non-prohibition regime. (a) Draw a graph of the illegal-drugs market under the two regimes. (b) Show and compare the drug-seller revenues under the two regimes. Explain.

Answer 1

The illegal-drugs market is drawn below. Demand curve is inelastic because consumers are willing to pay a higher price for drugs. Suppliers in case of no prohbition will supply more so the supply curve is more elastic. With prohibition, supply will be highly inelastic as drug dealers will have a higher reservation price for each drug supplied.

Area ADFB represents the revenue in no prohbition market where market equilibrium has a lower price AD and a higher quantity AB. The revenue is smaller. Area ACEH represents the revenue in a prohbition market where market equilibrium has a higher price AC and a lower quantity AH. The revenue is larger