McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 17 Tobacco, Alcohol, Drugs, and Prostitution

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Outline AN ECONOMIC MODEL OF MARKET FOR TOBACCO AND ALCOHOL DRUGS AND PROSTITUTION ARGUMENTS FOR MAKING A GOOD ILLEGAL DECRIMINALIZING DRUGS AND PROSTITUTION

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Consumer and Producer Surplus Analysis Q/t P Demand Supply A P* B C 0 Q* Value to the Consumer: 0ACQ* Consumers Pay Producers: OP*CQ* The Variable Cost to Producers: OBCQ* Consumer Surplus: P*AC Producer Surplus: BP*C

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Arguments for Making a Good Illegal People have limited information about the good, are not capable of making a good decision about the good or the good is addictive and one-time users can not learn from their mistake. There are externalities, effects of a transaction that hurt or help people who are not a part of that transaction, involved in the production or consumption of the good. The good is immoral.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Preventing Bad Decisions Economists are typically reluctant to assume that people can not make good decisions. Drugs tend to be an exception to this rule because they are addictive. Ads appeal to children –Whaaazzuupp (how ya doin) –Joe Camel –NASCAR Winston Cup, Busch Series –Virginia Slims Tennis

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Modeling Externalities S Marginal Cost D (Marginal Benefit) Q* P* P The Offending Good 0 Social Cost External Cost Q’ P’

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Examining the Externalities Tobacco accounts for approximately $1 per pack in costs incurred by taxpayers and nonsmokers. –Medicare, Medicaid, Asthma, Drunk Driving accounts for one-third of the 37,000 traffic accidents that cause 42,000 deaths 28% of all violent crimes (44% for rapes) are committed while the perpetrator is on drugs. 55% of inmates in jail, detention, or prison used drugs during the month leading up to their arrest.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Battling Negative Externalities While Creating Others Much of the drug violence that exists, only exists because of laws criminalizing drug use. If cocaine, methamphetamine, and marijuana were legal and inexpensive, –there would be less of a need for addicts to rob in order to get money to buy them. –there would be no drive-by shootings to protect turf.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. A Twist on the Externalities Argument for Tobacco Cigarette smokers are more likely to die – at an earlier age than they would have otherwise died. –in a less costly manner than they would have otherwise died. (e.g. heart attack rather than Alzheimer’s.) Some economists estimate that this effect saves Social Security, Medicare and Medicaid (because they are not in nursing homes) more money than the $1 per pack in estimated external costs.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Using Taxes to Correct for Externalities S Marginal Cost D (Marginal Benefit) Q* P* P Tobacco/Alcohol 0 Social Cost=S+tax External Cost=tax Q’ P’

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The Tobacco Settlement and why Elasticity Matters 1998 settlement between several states and several tobacco companies $250 billion spread over 20 years Demand for tobacco products is fairly inelastic. This means that the percentage change in prices will be more than the percentage reduction in smoking.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. A Tax on Tobacco with Inelastic Demand S Marginal Cost D (Marginal Benefit) Q* P* P Tobacco/Alcohol 0 S+tax tax Q’ P’

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Elasticity Estimates Elasticity of Demand –for Tobacco -.2 for adults -.5 for children –For Beer -.53 Implications –A dollar increase in the tax on cigarettes would reduce consumption by adults by 10% and reduce consumption by children by 25%.

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The Importance of Elasticity for Drugs If people are addicted to a particular drug, their demand for it will be inelastic. Drug interdiction efforts shift the supply curve to the left. This will cause prices to rise –Addicts will not reduce quantity demanded much –Recreational users will reduce quantity demanded more

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The Impact of Decriminalizing Drugs or Prostitution S illegal D illegal D legal S legal Q legal P legal Q illegal P illegal P Q

McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Legalization with Taxes Applying Figure 17.5 to drugs, legalization could deal with the external costs. Making the tax too high would induce a black market.