South-Western College Publishing - Economics  
The Economics of Drug Dealing
Subject Equilibrium and Comparative Statics
Topic Monopoly
Key Words Wholesalers, Distributors, Franchises, Profit, Costs, Revenues
News Story

Drug distribution is handled much like any franchised business. A central gang acts as the wholesaler. Individual gangs are the distributors. They pay a flat franchise fee to the central gang for the right to sell drugs in a particular territory.

A drug gang makes about 80 percent gross profit (calculated as the revenues minus the cost of the drugs sold). However, they then have operating expenses such as the wages paid to officers and pushers, weapons, the franchise fee (called a tribute), mercenary fighters, and funeral expenses. These expenses can reduce the net profit to small levels, although other gang activities such as extortion can offset this. If there is a gang war, fewer drugs are sold, and wage costs fall, but the cost of weapons, mercenaries, and funerals rise; overall, costs may decrease slightly, while revenues may decline significantly, leading to losses.

Thus there is surprisingly little money to be made in drug distribution at the franchise level. Pushers receive barely what they would make flipping burgers. The people who do well are high up in the organization at the central gang level. (Updated October 15, 1998)
Questions

1. What are the defining assumptions or characteristics of a monopoly? Given your answer, are there area monopolies in the market for illegal drugs? Explain. What factors create and preserve the monopoly?

2. Assume that there are area monopolies in the illegal drug market.
a) For one such monopoly, draw the marginal and average total cost curves, the demand curve and the marginal revenue curve. Show the profit-maximizing equilibrium price and quantity of drugs. Shade in the area representing profit.
b) How do you explain the amount of profit in the illegal drug market? Refer to your diagram.

3. Occasionally, gang wars break out as other gangs try to wrest the monopoly away from the incumbent gang.
a) At the side of the diagram you drew for Question 2, draw another one but with lower costs and even lower demand. Draw the equilibrium price and quantity and the profit area.
b) Explain what has happened as a result of the drug war.
Source Scott Woolley, "Greedy bosses," Forbes Magazine, August 24, 1998

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