Economics of Drug Addiction

1. Economics of Drug Addiction ECON 3670 Applications of Choice Theory Roberto Martinez-Espiñeira

2. 1 Introduction • Marshall (1890) in his famous book, Principles of Economics: • “ Whether a commodity conforms to the law of diminishing or increasing return, the increase in consumption arising from a fall in price is gradual: and, further, habits which have once grown up around the use of a commodity while its price are low are not so quickly abandoned when its price rises again”

3. 2 Introduction Phlips (1983) notes that Marshall captures the three key aspects of addiction: • physical response (tolerance) • irreversibility (withdrawal), • and positive effects of habits (reinforcement)

4. 3 Introduction • Most economists since Marshall have tended to view addicts as myopic, imperfectly rational individuals whose behavior is not conducive to standard economic analysis • Thomas Schelling (1978) in describing a smoker who wishes to ‘kick the habit’ • “Everybody behaves like two people, one who wants clean lungs and long life and another who adores tobacco…The two are in a continual contest for control; the ‘straight’ one often in command most of the time, but the wayward one needing only to get occasional control to spoil the other’s best laid plan”

5. 4 Introduction Let us see how the tools of economics can be used to understand drug addiction • brief overview of the nature and extent of global illicit drug use • how economists define addiction versus those from other disciplines

6. 5 Using Illicit Drug Statistics • It is hard to obtain reliable and consistent data relating to several topics covered in this course • Illicit drugs are no exception • a largely ‘hidden’ activity • difficult to observe the market price of an activity that does not enter an official market • the figures economists work with in this area tend to be drawn from either drug users’ self-completion surveys or derived indirectly from other data

7. 6 Global Illicit Drug Use • The official source of data for global illicit drug use is the United Nations Drug Control Program (UNDCP) • The table in Slide #7 shows that over the 2003-04 period, the total number of illicit drug users was estimated to be 200 million, equivalent to 3.2% of the global population, or 5% of the population aged 15 and above • The table also shows that cannabis (marijuana) is the most commonly used substance, followed by amphetamine-type substances

8. Latest data available at • http://www.unodc.org/wdr2015/ • And • http://www.emcdda.europa.eu/data/stats2015

9. 7 Global Illicit Drug Use – 2003-04

10. 8 Global Illicit Drug Use • The figures on Slides #9 and 10 show some cross-country comparisons • Think about how you would explain the differences in reported drug use as well as ‘lifetime experience’ versus ‘recent use’

11. 9 Lifetime Prevalence of Illicit Drug Use in USA, Australia, and Europe

12. 10 Last Year Prevalence of Illicit Drug Use in USA, Australia, and Europe

13. 11 Theories of Addiction • help explain how an individual may cross the threshold from casual drug use to consumption which may be deemed addictive • Non-economists define addiction as a behavior over which an individual has impaired control with harmful consequences • West (2001) classifies theories of addiction into five categories

14. 12 Theories of Addiction • (1) theories that “attempt to provide broad insights into the conceptualization of addiction” • explaining addiction in terms of biological, social, or psychological factors • E.g. Betz et al. (2000) examines whether a common biochemical mechanism may underlie addictions

15. 13 Theories of Addiction • (2) those that try to “explain why particular stimuli have a propensity to becoming a focus for addiction” • The positive and reinforcing properties of addictive drugs have been widely investigated • Robinson and Berridge (1993) suggest that these properties are enhanced rather than lessened by repeated exposure

16. 14 Theories of Addiction • (3) third group examines, ‘why particular individuals are more susceptible to addiction than others’ • Cheng et al. (2000) and Cunningham et al. (1992) investigate whether this susceptibility may be genetic

17. 15 Theories of Addiction • (4) fourth group addresses “the environmental and social conditions which make addiction more or less likely” • An individual may find himself in a particular situation which triggers the need for the effects of a stimulus, or in which those effects take on a greater significance • Kenkel et al. (2001) examine the role of economic factors in the initiation and progression of drug use in this context

18. 16 Theories of Addiction • (5) fifth group “focuses on recovery and relapse…some are broad perspectives, other focus on effects of withdrawal from particular stimuli such as drugs; still others focus on individual factors and others seek to model environmental influences” • An important contribution in this field is Prochaska and DiClemente’s (1983) Transtheoretical Model which identifies stages of change and other factors that predict treatment outcomes

19. 17 Theories of Addiction • Economists focus on a good being addictive if an increase in the stock of past consumption results in an increase in current consumption, ceteris paribus • In particular, an economist is interested in rationalizing the observed behavior of an addicted individual • Rationalizing means to seek an explanation which identifies the individual’s objectives, preferences, and constraints so that a rule can be derived to predict the behavior

20. 19 Theories of Addiction • Our focus is to rationalize harmful addiction (increasing consumption of a good or activity which has, for example, detrimental future effects upon one’s health) • Of course, theories of addiction can explain also beneficial addiction (e.g. reading of one’s favorite novel over and over again, playing a musical instrument, jogging, etc.)

21. 20 Theories of Addiction • All behavioral theories of addiction assume that the amount of addictive good consumed in the past has lasting effects of some sort • Higher past consumption may result in a modification of the consumer’s preferences, that is, the extent to which he or she ‘likes’ to consume the addictive good

22. 21 Theories of Addiction • Someone ingests more heroin now since past consumption of the drug has increased his tolerance for the drug • requiring larger amounts of the drug to derive the same degree of satisfaction as experienced in the past

23. 22 Relative theory of addiction • Stigler and Becker (1977) were among the first economists to rationalize the behavior of increasing consumption of a good or activity • Their relative theory of addiction stands in the economic tradition of the common preference approach, that is, they attempt to explain differences in behavior across individuals by differences in economic constraints, as opposed to the individual’s objectives or preferences

24. 23 Relative theory of addiction • Rather than assuming a relationship between previous amounts of consumption of a drug and preferences to explain addiction, Stigler and Becker present a theory which posits a feedback between consumption and its effective price as perceived by the individual

25. 24 Relative theory of addiction • Assume individuals have a preference for ‘euphoria’, which is home-produced • However, the effective price of one unit of euphoria can be derived from information on the cost of the inputs used in the production of euphoria and on the technology used to produce euphoria • E.g. price of heroin and risk of getting caught using heroin

26. 25Relative theory of addiction • The production of euphoria also depends on individual-specific ability to experience the sensation • Known as euphoric capital or, more generally, consumption capital • Stigler and Becker introduce a feedback between past euphoria and the euphoric capital stock at present • i.e. the euphoric capital depends on previous amounts of euphoria experienced

27. 26 Relative theory of addiction • The theory predicts that, under certain conditions, the demand for inputs in the production process increases while the euphoric capital and amount of euphoria decreases • Thus explaining an individual’s path of rising demand for the drug while the consumption of euphoria is falling and the price of drug remains constant • The condition necessary for this to occur is a sufficiently inelastic demand for euphoria

28. 27 Melioration Theory of Addiction (‘Primrose Path’) • Herrnstein and Prelec (1992) explain why individuals may deliberately choose a path of increasing consumption of a harmful good or activity

29. 27 Melioration Theory of Addiction (‘Primrose Path’) • In the figure Point A shows the instantaneous payoff to an alternative activity (‘going out with friends’) if the individual has never experimented with heroin • Point B shows the payoff to using heroin if this is the individual’s first experience of it • Rational for the individual to choose to use heroin for the first time and experiment with mixing the frequency of the drug use and the alternative activity

30. 28 Melioration Theory of Addiction (‘Primrose Path’)

31. 29 Melioration Theory of Addiction (‘Primrose Path’) • Melioration theory considers that the payoffs over time to these actions are path-dependent (they depend on the history of drug use) • Light solid line is the payoff to the alternative activity (going out with friends) given the individual’s recent history of drug use • Dashed line is the payoff to using heroin • Dark solid line shows the weighted average payoff to all actions undertaken by the individual through time

32. 30 Melioration Theory of Addiction (‘Primrose Path’) • Point C on the solid line represents the highest possible average payoff for the individual (where the MB of heroin use equals MC) • Melioration theory argues that point D is the equilibrium solution because beyond point C, the instantaneous payoff to heroin use is still greater • incentive to increase heroin use until the payoffs from both activities are equalized (point D)

33. 31 Melioration Theory of Addiction (‘Primrose Path’) • At D, the individual is worse off than had he not started using heroin • The average payoff from both activities at D is lower than the associated payoff associated with A • The individual has ventured down a ‘primrose path’ of addiction, initially believing there was little danger of losing control but eventually becoming ‘trapped’ • Each individual decision made by the individual along this path was rational, the sequence of decisions was certainly not rational

34. 32 Theory of Rational Addiction • The melioration theory of addiction is criticized for assuming that an individual is unable to anticipate future consequences of his activities • How increasing consumption of a harmful good is possible among individuals who are fully aware of their current choice is addressed by Becker and Murphy (1988) in their theory of rational addiction

35. 33 Theory of Rational Addiction • The rational addiction theory is the most influential economic theory of addiction to date • It builds on the relative theory of addiction, but assumes that instead of consuming heroin-induced euphoria, the individual derives utility from consuming the heroin itself • NB: We present here a more basic version of the theory than the one presented in the book

36. 34Theory of Rational Addiction • formally derives aspects of dynamic consumption behavior with respect to an addictive good • individuals consider consequences of their decisions on future outcomes => more rational than previous models that assume myopic behavior

37. 35 Theory of Rational Addiction Here is an equation that can help spell out the important aspects of the theory: Ct = αCt-1 + βαCt+1 + δPt • Ct = consumption of drug at time t (today) • Ct-1 = consumption of drug at time t-1 (yesterday or last week) • Ct+1 = consumption of drug at time t+1 (tomorrow or next week) • Pt = price of drug at time t (today)

38. Ct = αCt-1 + βαCt+1 + δPt • α measures the effect of an increase in past consumption (Ct-1) on marginal benefit of current consumption (Ct) and effect of increase in future consumption (Ct+1) on marginal benefit of current consumption (Ct) • α is assumed to be positive (i.e. current consumption is positively related to past and future consumption)

39. Ct = αCt-1 + βαCt+1 + δPt • β is a time-discount factor (measures rate of preference for the present) • Assume βis smaller than 1. Individuals prefer to consume 100 units of drug today than wait until tomorrow to consume same amount • The more heavily the future is discounted (the smaller is β), the more likely that a consumption path is followed that leads to addiction • for a myopic individual (someone who completely discounts the future) β = 0 • δmeasures extent to which changes in price of drug affect consumption of drug and is assumed to be negative

40. 38 Theory of Rational Addiction • Ct = αCt-1 + βαCt+1 + δPt • Past consumption reinforces current consumption here, so the short-run price elasticity must be smaller than the long-run price elasticity • If the price of a drug increases in the current period, this will decrease current consumption (Ct) which in turn reduces the marginal utility of consumption next period and thus also reduces future consumption • by symmetry, an anticipated increase in the price of the addictive drug in the future should reduce consumption in the present because the consumer is forward-looking

41. 39 Theory of Rational Addiction • In summary, there are three main predictions of this model: • (1) The more heavily the future is discounted the more likely that addiction arises • (2) the higher the effective price of a drug (including opportunity costs of consumption such as lost life-cycle wages), the less likely that an individual will become addicted • (3) demand for a drug will be more elastic in the long-run than in the short-run

42. 40 Hyperbolic Discounting • The Rational Addiction model has been criticized for assuming that individual makes time-consistent choices

43. 40 Hyperbolic Discounting • Time-consistent choices are imposed by assuming that an individual discounts the value of future rewards according to an exponential function • future utilities U(Xt) are discounted by a weight δt which is an exponentially declining function of t (meaning that the value of future utilities will decline by a constant proportion every period) • An exponential function assumes constant discount rates and assumes that an individual’s relative evaluation of two rewards will depend only on the amount of delay between receiving them

44. 41 Hyperbolic Discounting • One way of rationalizing time-inconsistent behavior is to introduce time preferences so that the individual discounts the value of future rewards according to a hyperbolic function where discount rates are declining (Laibson, 1997) • Delayed rewards are weighted by βδt where β represents the preference for immediate reward and δ expresses the preference for reward delayed t periods, relative to a delay of t+1 periods

45. 42 Hyperbolic Discounting • Hyperbolic functions have the potential to exhibit preference reversals • For instance, in the figure, the problem for individual is to get through day without using heroin • The dashed line represents the present value of scoring heroin, while the solid line is the present value of going out his girlfriend • Point T1 is the possibility of scoring heroin (good) and T2 is the possibility of meeting his girlfriend (even better)

46. 43 Hyperbolic Discounting Summed Reward Value Preference Reversal Time (delay = t – tn) T3 T1 T2

47. 44 Hyperbolic Discounting • Almost all day, the individual prefers the idea of meeting his girlfriend, but because of hyperbolic discounting, it may be that as the opportunity to score heroin comes closer and closer, he will begin to value it more • At T3, a preference reversal takes place, illustrating the idea that drug addicts tend to have a preference for ‘small-early’ rewards over ‘later-larger’ rewards

48. 45 Hyperbolic Discounting • An initial preference for a ‘later-large’ reward over a ‘small-early’ reward reverses as the latter approaches, ‘with an advance choice of virtue changing to an immediate choice of vice’ (Read and Van Leeuwen, 1998) • This explains the surrender to temptation that is often characteristic of an addict’s behavior

49. 46 Price Elasticity of Demand: Theory • Moore (1973, 1990) –drug users will be concerned with a drug’s ‘effective’ or ‘shadow’ price which includes the money price, but also other components such as: • the perceived risk of both acquiring and taking the drug • the probability of getting arrested, convicted, fined, or imprisoned • the ‘search time’ involved

50. 46 Price Elasticity of Demand: Theory This search time will differ: • from buyer to buyer • from market to market • and from time to time and is essentially a measure of an illicit drug’s availability