The Market for Illegal Goods: The Case of Drugs
This paper considers the costs of reducing consumption of a good by making its production illegal, and punishing apprehended illegal producers. We use illegal drugs as a prominent example.
We show that the more inelastic is either demand or supply for a good, the greater is the increase in social cost from further reducing its production by greater enforcement efforts. So optimal public expenditures on apprehension and conviction of illegal suppliers depend not only on the difference between the social and private values from consumption, but also on these elasticities.
When demand and supply are not too elastic, it does not pay to enforce any prohibition unless the social value is negative. We also show that a monetary tax could cause a greater reduction in output and increase in price than would optimal enforcement against the same good if it is illegal, even though some producers may go underground to avoid a monetary tax. When enforcement is costly, excise taxes and quantity restrictions are not equivalent.