Decision-Making Under Risk in the Market for Illegal Drugs: A Supply-Side Analysis

Most economic models of the illegal drugs market focus on demand-side behavior. However, in imperfectly competitive markets such as the illegal drugs market, it is the seller who determines price. Moreover, even models that focus on supply-side behavior often ignore key factors such as risk. This paper develops an expected utility model of a risk-averse seller. We find that under risk aversion, increasing punishment costs (i.e., severity) is more effective than increased enforcement (i.e., certainty) and demand reduction is more effective than interdiction. If risk neutrality is assumed, increases in severity and certainty have the same deterrent effect. Under risk neutrality, the deterrent effect of demand reduction policies dominates all other interdiction policies. These results lend theoretical reinforcement to the growing policy bias in favor of demand-side intervention.