QUESTION 1 - THE WAR ON DRUGS (modified from final exam, Spring 2009)

Suppose we believe that the use of illegal drugs is a public bad - that is, that one person's drug use imposes a negative externality on the rest of society. (This could happen, for example, through increased rates of other crime and general lawlessness, or through health consequences that must be paid for through higher taxes.)

Anti-drug enforcement means that both suppliers and buyers face a risk of being caught and punished. This raises the marginal cost for suppliers, and also raises the effective price of drugs faced by buyers (the cash price plus the expected punishment).Suppose the street price of drugs is a fixed markup above the dealer's marginal cost.

(a) Consider a proposal to focus additional enforcement efforts on suppliers, by increasing Coast Guard patrols to catch a higher fraction of people importing drugs into the country. What effect will this have on the price of drugs?

(b) Consider a proposal to focus additional enforcement efforts on buyers, by hiring more undercover police to sell drugs and arrest the people who buy from them. What will be the effect on the actual cash price of drugs? On the effective price faced by buyers?

Drug users tend to fall into two categories: casual (occasional) users and addicts. Suppose that casual users tend to be wealthier, and therefore attach a much greater financial disutility to jail time. (For example, a typical casual user might equate one year of jail time to a cost of $100,000, while a typical drug addict might equate it to $20,000.)

(c) Would the crackdown on suppliers impact the effective price (cash plus expected punishment) of drugs faced by casual users more, less, or the same as the effective price faced by addicts?

(d) Would the crackdown on buyers impact the effective price of drugs faced by casual users more, less, or the same as the effective price faced by addicts?

Casual drug users tend to have very elastic demand - so higher prices lead to lower consumption, reducing the social cost of drug use and the cost of punishing those who are caught. Drug addicts, on the other hand, have very inelastic demand, so increased prices have little deterrence effect. In addition, many addicts support their habit through robberies and other crimes, so higher prices lead to more crimes by drug addicts (to support the same level of use at higher prices).

(e) Based on these facts, Cooter and Ulen argue that the "ideal" drug policy might be a high price of drugs for casual users, but a low price for addicts. Which of the two proposals described above - the crackdown on suppliers or the crackdown on buyers - comes closer to achieving this goal?