Drugs, Prostitution, and the Economics of Black Markets

1. Drugs, Prostitution, and the Economics of Black Markets

2. Overview • Recap of Black Markets • Drugs+Gangs • Economics of Prostitution • Economic Model

4. Drugs and Gangs

5. Invention of Crack Cocaine • •Technological advance – supply “shifter” • •All other things equal • •Lower equilibrium price

6. 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

7. The Formation and Operation of a Regional Monopoly • •Monopoly distribution of crack cocaine in gang “turf” • •Downward sloping elastic demand curve • •Economic profit

8. Fixed and Variable Costs • •FC = Short-run costs • Bribes, Family Assistance, Weaponry • •VC = the product • Drugs, Street dealers, mercenaries

9. “Winner Take All” • •Common market structure (baseball players) • •Low Success, High Return • •Illegality drives competition

10. A Model for Labor • •Far right of origin • •Workers taken together require lower wages • •Represents low W*

11. CEOs of Gangs? • •Top 120 managers represented just 2.2%, > half the profit • •Investor reward of black market intact

12. Prostitution

13. 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

14. 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?

15. 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

17. 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

19. 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

20. 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

21. 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

22. 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

23. 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%

24. 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

25. 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)

26. 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

27. L&K’s Crime Model cont. •Equations After Introduction of Sentence Enhancements •First Period •Second Period

28. 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

29. 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