mated price function. Figure 3.3 shows the resulting price index series. The price index tends to decrease from years 1 to 8, but there is an upward fluctuation in year 5. The index increases from years 8 to 10. However, the trend and fluctuations shown in Figure 3.3 are artifacts of the pooling of the data from cities 1 and 2. The true average price of 1 gm of cocaine does not vary over time in either city. Thus, the price index obtained from the pooled data is highly misleading. Pooling has given rise to the appearance of price trends and fluctuations that do not exist in the markets in which the data were collected.
Misleading results such as those illustrated in Figure 3.3 can be avoided by estimating separate price functions for each time period (e.g., year), market (e.g., city in the example), and commodity of interest. The price function for a given time period, market, and commodity is used to estimate the price of one unit of the commodity in that time period and market. A combined price index is constructed as a weighted average of the prices obtained for all commodities and markets in the given time period. If there are several different amounts or purities of interest, then the estimated price of each can be included in the weighted average. The weight assigned to a particular market and commodity is proportional to the quantity of the commodity that is sold in that market. The weights can be based on quantities sold in a base year or they can be based on yearly sales volumes. In the former case, the price index varies over time only if market prices vary. In the latter case, the price index also reflects variations in the relative sales volumes of different commodities and in different markets. The relative merits of different weighting schemes are discussed in economics textbooks and depend to some extent on the intended use of the price index. The committee does not take a position on which weighting scheme is best for drug policy analysis.
To date, most of the research constructing or using prices on illegal drugs has not relied on the extensive research and practical experience on price indices that exists in the federal government and in the academic community. The committee notes that the principles underlying the construction of price indices are well established in the official national statistical community. For example, the Bureau of Labor Statistics uses standard and well-tested procedures to construct retail and wholesale price indices, taking into account regional differences, seasonal variation, and other factors.
The committee recommends that a major effort be devoted to “importing” standard procedures on constructing price indices into the development of price indices for illegal drugs. This effort should take place in collaboration with federal statistical agencies that specialize in this area, particularly the Bureau of Labor Statistics. Appropriate techniques would address a number of important issues. Aggregating across