Chapter 21 The Line Between Legal and Illegal Goods

1. Chapter 21The Line Between Legal and Illegal Goods

2. Chapter Outline • An Economic Model Of Market For Tobacco, Alcohol and Illegal Goods and Services. • Why is Regulation Warranted? • Taxes on Tobacco and Alcohol • Why are Certain Goods and Services Illegal?

3. P Supply A P* B C Demand 0 Q* Q/t Consumer and Producer Surplus Analysis • Value to the Consumer: • 0ACQ* • Consumers Pay Producers: • OP*CQ* • The Variable Cost to Producers: • OBCQ* • Consumer Surplus: • P*AC • Producer Surplus: • BP*C

4. 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.

5. 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.

6. Social Cost External Cost P SMarginal Cost P’ P* D(Marginal Benefit) 0 Q’ Q* The Offending Good Modeling Externalities

7. Examining the Externalities • Tobacco accounts for approximately $1 per pack in costs incurred by taxpayers and nonsmokers. • Medicare, Medicaid, Asthma • Drunk Driving accounts for 42% of the 37,000 traffic accidents that cause 33,963 deaths. • 27% of all violent crimes (37% for rapes) are committed while the perpetrator is on drugs. • 36% of inmates in jail, detention, or prison used drugs during the month leading up to their arrest.

8. 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.

9. 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.

10. Social Cost=S+tax External Cost=tax P SMarginal Cost P’ P* D(Marginal Benefit) 0 Q’ Q* Tobacco/Alcohol Using Taxes to Correct for Externalities

11. 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

12. S+tax tax P’ Q’ A Tax on Tobacco with Inelastic Demand P SMarginal Cost P* D(Marginal Benefit) Q* 0 Tobacco/Alcohol

13. 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%.

14. 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

15. P Sillegal Slegal Pillegal Plegal Dlegal Dillegal Qillegal Q Qlegal The Impact of Decriminalizing Drugs or Prostitution

16. Legalization with Taxes • Applying Figure 21.5 to drugs, legalization could deal with the external costs. • Making the tax too high would induce a black market.