Markets for illegal goods

So far in this chapter we have considered situations in which an activity is deemed illegal but where there is no market for the good or activity under consideration. But many illegal goods and services (such as drugs, weapons, gambling, prostitution, and abortion) take place in market settings, with producers, consumers and market prices. This section extends the basic principles of the analysis in the earlier part of the chapter to deal with illegal markets.1

Suppose that there is a good whose marginal and average production cost is constant and equal to c > 0 for each firm in the industry. Since all firms are alike and since marginal costs are constant, we can treat firms in the industry as a single price-taking firm with output of Q and the same cost function. Suppose that it is illegal to supply the good. Let p be the probability that a producer is caught selling the good. Let us assume that the producer faces two kinds of punishment. If a producer is caught, production is confiscated and destroyed, and a fine of $f per unit of the good is also imposed. The two questions of interest are:

  • 1. How will participants in this market behave? and
  • 2. What is the efficient p and f ?
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