Below is a summary of Don Kenkel‘s lecture regarding the Economics of Substance
The World Health Organization and the United Nations International Drug Control Programme (UNDCP) have statistics on the number of drug users around the world. They claim that in 2002 there were 2 billion alcohol users, 1.3 billion smokers, and 185 million illicit drug users. These number represent 32%, 21% and 3% of the world’s population. Of illegal drug users, 69% use cannabis, 16% amphetamines, 6% cocaine, 4% heroin, 3% ecstasy and the rest other opiates.
Defining what the term ‘substance’ is also difficult. Alcohol and marijuana have been legal and illegal in different times and places. Is caffeine a substance? What about prescription drugs? Are betel or khat substances?
Rational Addiction Model
Kenkel briefly discusses a model of a rational addict. The rational addict is forward looking and takes into account that choice of consumption today will affect the marginal utility of consuming the substance in the next period. A rational addict may have the following utility function:
- Σβt-1 U(Ct,Ct-1, Yt, et)
- s.t.: It=Yt+pCt
- C: number of cigarettes, Y: other consumption goods, I: Income
Assuming a quadratic utility function, one can show that the structural demand equation is:
This can be estimated using 2SLS with Pt-1, Pt+1 as instruments for Ct-1, Ct+1.
The rational addiction model is appealing for a number of reasons. It explains many features of addictive consumption and features two unstable steady states: one with low and one with high consumption of cigarettes. Life cycles shocks can move consumers from the low to high cigarette consumption states. The model also explains why quitting cold turkey can be optimal.
Quasi Hyperbolic Discounting
This was developed by Laibson (1997). The utility function is time-inconsistent in that the future is discounted by more than the present. For instance:
- Ut=ut + δΣβτ-1 uτ
The term δ represents the taste for immediate gratification. Psychological experiments tend to confirm quasi-hyperbolic discounting. Undergraduates given choices between a delayed reward of $1000 and immediate rewards ranging from $1 to $1000 revealed a year 1 discount rate of 60%, but a 16% discount rate for years 2-5. Also, this model would explain the existence of commitment devices (e.g.: former smokers supporting restaurant smoking bans as a commitment device).
Cue triggered addiction
The seminal work here is Berheim and Rangel (AER 2004). The paper claims that individuals operate in either a ‘cold’ mode where decision processes are made rationally, and a ‘hot’ mode where decisions and preferences diverge and this results in substance use. Addicts know they make bad decisions while in hot mode and can choose their lifestyle to alter the probability of being in the hot mode. The Neuroeconomics blog from George Mason University has some commentary on this paper.
Entertaining quotation regarding the 1998 Master Settlement Agreement.
Q: Could you please explain the recent historic tobacco settlement?
A: Sure. Basically, the tobacco industry has admitted that it is killing people by the millions, and has agreed that from now on it will do this under the strict supervision of the federal government.