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Drugs, Prostitution, and the Economics of Black Markets. Overview. Recap of Black Markets Drugs+Gangs Economics of Prostitution Economic Model. Drugs and Gangs. Invention of Crack Cocaine. •Technological advance – supply “shifter” •All other things equal •Lower equilibrium price.
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Overview • Recap of Black Markets • Drugs+Gangs • Economics of Prostitution • Economic Model
Invention of Crack Cocaine • •Technological advance – supply “shifter” • •All other things equal • •Lower equilibrium price
Conflicting Incentives: owner versus labor • •Owners seek to maximize profit • –Create stable and safe market environment • •Worker seeks to maximize pay • –Move up the rank -> higher pay • •Gang war
The Formation and Operation of a Regional Monopoly • •Monopoly distribution of crack cocaine in gang “turf” • •Downward sloping elastic demand curve • •Economic profit
Fixed and Variable Costs • •FC = Short-run costs • Bribes, Family Assistance, Weaponry • •VC = the product • Drugs, Street dealers, mercenaries
“Winner Take All” • •Common market structure (baseball players) • •Low Success, High Return • •Illegality drives competition
A Model for Labor • •Far right of origin • •Workers taken together require lower wages • •Represents low W*
CEOs of Gangs? • •Top 120 managers represented just 2.2%, > half the profit • •Investor reward of black market intact
History • In the 1910s estimated to be 200,000 women prostitutes in US • 1 of every 50 women in their twenties was a prostitute • At the time a common prostitute working in Chicago would make $76,000 annually in today's money • A prostitute working in an upscale brothel at the same time would make about $430,000 annually in today's terms • Reported that one head of brothel accumulated as much as $22 million
Current Day • Typical prostitute in Chicago works 13 hours a week • Performs 10 sexual acts per week • Average hourly wage of $27, weekly pay of $350 • The wages of prostitutes have fallen dramatically over the last 100 years, why?
Supply and Demand • Demand has noticeably fallen • Not for sex, but for paid sex • Social trends involving sex have evolved greatly • The arrest of many prostitutes has also caused a shift in supply, though not great
Elasticity • The demand for prostitutes has shown to be rather inelastic • Illustrated by two examples: • As prostitutes were arrested, supply dropped which elevated the equilibrium price. Demand stayed the same as customers continued to pay the elevated wages • Allie, a high end prostitute, consistently raised her prices but did not experience a decrease in demand for her services
Price Discrimination • Prostitutes reported charging different rates based on skin color • Named the price to African- American customers, allowed White customers to name the price • Black customers pay on average $9 less per sexual act than White customers
Substitutes and Product Differentiation • Prices at a certain location are the same from one prostitute to another • Customers look at prostitutes as Perfect Substitutes that can be easily interchanged • Firms, in this case brothels, can experiencing great benefits from providing slight different products
Incentives, Incentives, Incentives • Like all markets, prostitution is ultimately driven by incentives. • The bottom line is that the incentives provided by prostitution are enough to create a consistent amount of people willing to sell their bodies • On the other hand, the incentives of paying for a prostitute continue to be enough to cultivate a demand for prostitution
Reducing Crime Rates • •Deterrent Effect: Increasing the potency or likelihood of negative consequences for a criminal • •Incapacitation Effect: Preventing a criminal from being able to perpetrate a crime
Sentence Enhancements • Type of crime Deterrent • Increased punishments that are added onto prison sentences that would have been served anyway • Example: •Proposition 8 (1982) in California •10% reduction in eligible crimes after 1 year •After 3 years, had fallen roughly 20-40%
Sentence Enhancements cont. •Deterrent Effect vs. Incapacitation Effect •Threat of going to jail for a longer time vs. Being in jail for a longer time •Can often save government money
Levitt & Kessler’s Crime Model •Equations before introduction of Sentence Enhancements •1. Maximization •(ri-ptJt(S))Cit •2. Crime Level •Ct=1-(ptJt/R)-pt-1Ct-1 •Prison sentences in one period (t-1) are served in the following period (t)
Decoding • •r= Gain from committing a crime • •p= probability of being caught • •J= Utility loss from being jailed for a time period • •S= Periods of time sentenced (initially 1 period) • •C= Choice to commit a crime or not • •If yes, C=1, if no, C=0 • •R= distribution of ri for those who commit a crime • •1/R is the density of crimes • •t= current time period • •i stands for the individual in the calculation
L&K’s Crime Model cont. •Equations After Introduction of Sentence Enhancements •First Period •Second Period
Differences •Addition of variable d, the disutility of an additional period in prison •Additional emphasis on pt-1Ct-1 : people arrested from previous time period, pt-2Ct-2 : people arrested from two periods ago
Conditions of Levitt and Kessler’s Model •Agents involved are assumed to live for infinite time •Agents are assumed to be risk-neutral •Future Utilities are not discounted •Gains from crimes are kept, regardless of whether caught