The supply-and-demand model provides the basic economic framework for drug policy. Efforts to provide economic models of illegal markets go back at least four decades (e.g., Becker, 1968), but the standard economic model has key limitations in understanding illegal drug markets. The implicit features of many legal markets in modern economies—for example, quality certification and available legal mechanisms to guard against fraud—are typically absent from illegal drug markets. Moreover, many key variables are difficult to observe. Illegal drug markets are also characterized by complex features, such as addiction (which means responses to increases and decreases in prices may differ) and high search costs (so that consumers must invest time in finding information about the product) that are sometimes found in legal markets but that are difficult to incorporate in simple models.

Despite these limitations, the basic supply-and-demand model provides a specific language to explore causal pathways of proposed public policies. It provides a framework to interpret available data on observed prices and quantities of illegal substances in particular markets. It focuses attention on basic parameters—the sensitivity of supply and demand to prevailing prices, production technologies, and costs—that are influenced by public policy. Finally, these simple models provide points of departure for richer theoretical and empirical investigations of particular markets. Figure 2-1 presents a very basic model to illustrate the impact of a supply-side law enforcement intervention.

The market demand curve D1 slopes downward: at higher prices, users in the aggregate purchase a lower quantity of the drug in question. The market demand curve reflects two types of responses to higher prices: some drug users cut back on their consumption, while others may drop out of the market and become nonusers (at least of the drug in question). As is discussed below, addiction raises the possibility of asymmetry in that lower prices may increase participation; higher prices may not reduce participation in the short run.

The market supply curve S1 slopes upward: at higher prices, the supply network is willing to provide more drugs to the market. The market supply curve again reflects two types of responses to higher prices: some current suppliers expand the size of their drug-dealing business, and there may also be new entrants who provide new sources of supply.

A supply-side intervention—such as increased border interdiction or more intensive police actions against street dealers—causes the market supply curve to shift up, or alternatively to the left, to curve S2. The vertical distance between S1 and S2 may be interpreted as the increase in unit production and distribution costs induced by supply-side interventions.

This shift captures the idea that to compensate for the extra risks and