Question

Suppose the Australian government introduces a new anti-drug policy that: 1) imposes stiffer penalties on individuals who sell and manufacture drugs in Australia and 2) stems the flow of illegal drugs from other countries into Australia.

A) Using a supply and demand diagram, show how this policy is likely to affect the equilibrium price and quantity of drugs in Australia. Be sure to label both axes, the supply curve, the demand curve, any shifts in either curve induced by the new policy, and the equilibrium price and quantity before and after the new policy.

B) Under what conditions will this new policy reduce total expenditures on drugs?

C) Given that most drugs are addictive, briefly explain whether you think this assumption is likely to hold.

D) If the government were to instead introduce a new anti-drug policy that 1) educated young people about the dangers of drug use and 2) increased funding for drug rehabilitation programs, how would the total expenditure on drugs be likely to change? Carefully, explain your answer, making reference to how such a policy would affect the equilibrium price and quantity of drugs.

Answer 1

1. Suppose, the initial market conditions be represented by the figure (1). The market is in equilibrium at point E where the demand intersects the supply. Note that the demand curve is relatively inelastic in nature due to the addictive nature of the commodity. The equilibrium consumption is Q’ at the price P’.

Let the government impose a stiffer penalty of amount x on the individuals who sell and manufacture drugs in Australia. This is a soppy side shock. It won’t affect the taste and preferences of individuals. So, the demands curve will remain the same. Supply curve will move upward by the amount of penalty. The price of the good will increase from P’ to P₁’ by the amount x. The demand is relatively inelastic, the quantity demanded will fall less. This is shown in fig (2).

Stemming the flow of illegal drugs from other countries to Australia will directly affect the supply curve as there will be less quantity of drugs available for sale. The demand curve will remain unaffected as the taste and preferences of individuals will not change. The supply curve shifts upward by a greater amount depending on the amount of supply that was cut off. The price of the drugs will sky-rocket from P’ to P₁’ and the quantity demand will fall from Q’ to Q₁’. This is shown in fig (3).

2. The total expenditure on drugs is given by, E = Price of drugs (P’) * Quantity sold (Q’) So, the expenditure will be reduced if one of these two is reduced. Reduction of price is not an option in this market. The expenditure will reduce if the increase in price is less than the decrease in quantity, which will happen if the demand curve is relatively elastic in nature. This is shown in fig (4). The left-hand panel shows the case where demand is inelastic while the right-hand panel shows the case of elastic demand. The initial expenditure is given by the area AP’EQ’. After the imposition of the anti-drug policy, the expenditure becomes AP₁’E’Q₁’. With the same amount of supply shock, expenditure in the left panel is greater after penalty due to increased price and less than proportionate decrease in quantity, whereas, in the right-hand panel, a supply shock results in a greater fall in quantity demanded and thus expenditure decreases.

3. Drugs are highly addictive in nature. The preference for consumption of drugs will not change immediately. The drug becomes an essential commodity for the survival of its consumer. Consumers will not be able to decrease their consumption readily. So, the demand for drugs is likely to be less elastic. Consumers will be willing to pay more to maintain their consumption level. Thus the assumption of elastic demand is not likely to hold.

4. Since the nature of drugs is addictive, consumers will be willing to pay any amount to maintain their consumption level. The price increase in the market will be much higher than the quantity decrease and total expenditure will rise. To purchase drugs at a higher price, the number of criminal activities in the economy will increase since the consumers are willing to go to any extent to pay a higher price for the good. If the government instead introduces reformatory policies like educating young people about the dangers of drugs and increased drug rehabilitation programs, these will affect the demand curves directly. People will decrease their demand, which will decrease both the market price and quantity purchased and thus the total expenditure as well. This is shown in fig (5).