The Economics of Crime

THE BUSINESS The Economics of Crime The Economics Collection
MADJD-SADJADI
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Zagros Madjd-Sadjadi
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This book will guide you to a better understanding
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Economics of
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Crime
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management and leadership tional material of a more advanced mathematical
challenges during their and theoretical nature, which tends to be more
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The Economics of Crime
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Abstract
This book will guide readers to an understanding of effective public
policy designed to reduce criminality. By understanding how incentive
mechanisms affect criminal behavior, business managers may use this
information either to reduce criminal activity in their own enterprises
or to understand how unethical business decisions affect the wider
society. As we always do in such circumstances, we must make sacrices
to balance the competing interests. To accomplish this with a
minimum of disruption, at the end of many chapters there is a section
called For the Economist where additional material of a more
advanced mathematical and theoretical nature, which tends to be more
tangential to the non-economists, is provided. In so doing, economics
students, who typically have an advanced knowledge of modeling, can
be trained in a parallel fashion to those for whom economics is a new
eld and, as such, may have only had a high school or introductory level
exposure to economic science, if any at all.
Keywords
crime, economics, rational crimes, organized crime, victimless crimes,
marginal analysis, crimes against property, crimes against persons, game
theory, general equilibrium
Contents
About the author ................................................................................... ix
Preface ................................................................................................. xi
Introduction: Why Should Businesspeople Care About Crime? ................ xiii
Chapter 1 What Does Economics Have To Do

With Crime Anyway? .......................................................1
Chapter 2 Are Criminals Rational? Gary Beckers

Rational Criminal Thesis ................................................31
Chapter 3 Game Theory and the Victim/Perpetrator

Calculus..........................................................................65
Chapter 4 Organized Crime .......................................................... 83

Chapter 5 Victimless Crimes......................................................101
Chapter 6 Crimes Against Property...............................................121

Chapter 7 Crimes Against Persons ................................................151
Chapter 8 Public Policy ................................................................165

Conclusion .........................................................................................179
Notes .................................................................................................181
References ...........................................................................................183
Index .................................................................................................185
About the Author
Zagros Madjd-Sadjadi is Professor of Economics, Master of Healthcare
Administration Program Coordinator, and former Chair of Department
of Economics and Finance at Winston-Salem State University. He was
the rst Chief Economist of the City and County of San Francisco and
has developed a course in the economics of crime, corruption and ter-
rorism at Winston-Salem State University. He has written papers pub-
lished in top academic journals in economics, political science,
international relations, and criminal justice and has served as a reviewer
for research grant proposals through the U.S. Department of Homeland
Security. He has also received two research grants in the area of the eco-
nomics of crime and authored the textbook used for many years at San
Francisco State University in its Economics of Crime course.
Madjd-Sadjadi has a B.S. degree in Computer Science and a B.A.
(equivalent) in Economics from Sonoma State University. He holds a
PhD in Political Economy and Public Policy from the University of
Southern California and is a former Occidental Petroleum Canada-
United States Fulbright Scholar to the Institute for Intergovernmental
Relations at Queens University in Kingston, Ontario. He also won a
Haynes Dissertation Fellowship from the University of Southern Cali-
fornia for his research there.
He conducted a cost-benet analysis for the Center for Juvenile and
Criminal Justice in San Francisco on its highly successful implementa-
tion of the Streets to Work Program in San Francisco and Oakland and
his work detailing the unsustainable costs of Californias war on drugs
was cited in the ballot arguments in favor of Proposition 36, the Sub-
stance Abuse and Crime Prevention Act, which the voters of California
approved with 61% of the vote in the year 2000.
Preface
Economics students often emerge with a clear grasp of theory, but little
ability to apply it, especially in microeconomics. They leave with a
model they believe is relevant solely to market mechanisms, when it
actually is one suited for inquiry into all avenues of rational choice. At
the same time, there is a popular conception that criminals are decient
in some psychological, physiological, or sociological aspect that means
we need to either lock them all away or x the root causes of their
social deviancy. Neither is a entirely satisfactory response to crime.
Workers, employers, and managers have a stake in effective public
policy designed to reduce criminality. According to the Institute for
People with Criminal Records, approximately 3% of the U.S. popula-
tion will be in jail or prison for at least one day during any given year,
and nearly 30% of the population has a criminal record (including mis-
demeanors). Yet having a criminal record may be a bar to employment
and lead individuals who have paid their debts to society on a pathway
to recidivism. Thus, everyone from managers in companies considering
whether to bar felons from employment to individual voters considering
felony disenfranchisement laws, needs to understand how rational crim-
inals act and think.
By understanding how incentive mechanisms affect criminal behav-
ior, business managers may use this information to reduce criminal
activity in their own enterprises or to understand how unethical busi-
ness decisions affect the wider society. As we always do in such circum-
stances, we must make sacrices to balance the competing interests. To
accomplish this with a minimum of disruption, at, or near, the end of
some chapters is a section called For the Economist where material of
a more advanced mathematical and theoretical nature, which tends to
be more tangential to the non-economists, is provided. Thus, econom-
ics students with an advanced knowledge of modeling can be trained in
a parallel fashion to those for whom economics is a new eld and, as
xii PREFACE
such, may have only had a high school or introductory level exposure to
economics, if at all.
Rather than always use the convention of he or she or simply he
throughout, I will, at times, use she in my examples to remind the
reader criminality knows no gender. Finally, I encourage those inter-
ested in other areas of law to read my forthcoming companion book
from Business Expert Press, The Economics of Common and Civil Law.
Introduction: Why Should
Businesspeople Care About
Crime?
The cost of crime is staggering. Nearly 1% of all Americans are cur-
rently in jail or prison and about twice that number are under probation
or parole. In the United States, as high as 10% of the population has
committed a felony. Felony disenfranchisement laws can bar a person
from ever voting again in some states while businesses may ask potential
employees about prior convictions. Smoking marijuana, betting on a
Celtics game (except where gambling is legalized), viewing obscene mate-
rial over the Internet, or having one too many drinks before getting in a
car can mean, under 3 strikes provisions, a life prison sentence for some-
one with prior felony convictions. Spending on prisons, lost productive
capacity due to incarceration, costs to victims of time and medical
expenses, payments to security companies, and payments for insurance
against theft drain about $2.4 trillion a year from the U.S. economy
based on gures given by Anderson1 and adjusted for ination.
Business leaders who care about their businesses and the communi-
ties in which they reside and work have an active stake in this question.
A lower quality of life in areas replete with crime means fewer jobs and
property losses associated with vandalism and theft relegate certain
neighborhoods to retail deserts with few opportunities for residents to
acquire goods from businesses larger than small convenience markets.
High losses from shrinkage (the accounting term for retail losses of
all types) require higher gross margins and higher prices for everyone. In
2011, according to the University of Floridas National Retail Security
Survey, shrinkage accounted for 1.4% of sales, translating into $35 bil-
lion in losses. Of this, 25% was due to shoplifting, 45% was employee
theft, and 12% was administrative error. The remainder was caused by
spoilage, accidental losses, and vendor fraud. When one considers net
margins for retailers are typically between 1% and 5%, it should be
clear why business leaders must take all cost-effective measures possible
to reduce these losses.
xiv INTRODUCTION
According to the National Association for Shoplifting Prevention,

only 2% of all shoplifting incidents are caught by security and, of those
who are caught, only half are handed over to the police. Internet piracy
has reached epidemic proportions with billions of dollars in losses to the
computer software, lm, book, and music publishing industries.
This book will help you to better understand the incentives people
have to break the law and give you way to adjust those incentives so that
you and your business are not victimized. For example, bribery of corrupt
ofcials may seem to be the only way to get things done in some coun-
tries and those ofcials know that quarterly prots may depend on such
bribes. What is needed is a Credible Threat discussed in Chapter 3.
Businesses practice price discrimination, selling to different consu-
mers at different prices. A classic example is the academic book pub-
lisher who sells the same book to international and domestic audiences
at widely different prices. The pharmaceutical, software, and movie
industries engage in similar practices. An exposition of why this does
not always work is found in the section on Black and Grey Markets
in Chapter 2.
Many industries utilize undocumented workers and there is a debate
on how these workers affect wages. A discussion of this is found in
Chapter 5 on Segmented Labor Markets but the basic premise can be
expanded to any market where entry is restricted in one segment but
there is a competing segment that is unrestricted. For example, the use
of homeopathic medicine as a counter to traditional medicine may be
seen in this light.
Managers worrying about theft and its effect on prices would do
well to read the section on Supply-Side Changes found in Chapter 6
while those interested in reducing employee theft should read the sec-
tion on White Color Crime in the same chapter.
These are just a few of the examples in this book that have wide
application to legal businesses. The fact is the legal markets have always
had to deal with illegal ones and always will and managers who ignore
the economics of crime do so at their own peril.
CHAPTER 1
What Does Economics

Have to Do with
Crime Anyway?
In this chapter, we will examine how economics can be used to study crime
through what is called the rational actor model. There are, of course, lim-
itations to this approach. No discipline can claim a monopoly on the truth
but economics allows us to reduce criminal activity and lead to a better
society for everyone.
Why Study Crime?

In your lifetime, you will likely be a victim of multiple property crimes and
have a signicant chance of facing violent crime, most likely an assault. More
than 10 million crimes are reported every year to the police in the United
States; yet only a minority of crimes is reported. Over 5 million people are
arrested for victimless crimes (including driving under the inuence, drug
possession, prostitution, gambling, and the catch-all crime of disorderly
conduct) and about 11,000 are murdered. Yet crime rates have fallen dra-
matically over the past two decades. Since the early 1990s, the homicide rate
has been cut in half and overall crime has dropped by about 45%. Many
argue this is because of 3 strikes laws and reinstatement of the death pen-
alty, but Canadas laws have not been similarly toughened and it has seen
similar percentage drops, calling into question if public perception is a reality.
What Is a Crime?
Dening crime is tricky and carries certain complications. Crime is a trans-
gression of the law but laws vary between localities and time periods. From
1919 to 1933, it was illegal to serve alcoholic beverages in the United
2 THE ECONOMICS OF CRIME
States. Today, prohibition has been repealed, although laws exist to pre-
vent the sale of intoxicants to minors. In the 19th century, cocaine was
proclaimed the latest wonder drug, used mostly to treat pain but also
everything from allergies to drug addiction. It even was part of Coca-Colas
formula, which contained traces of it until 1906. Cocaine was sold over the
counter until 1914 when it was declared a controlled narcotic based on
high incidence of addiction.
When Jerry Lee Lewis visited England with his 14-year-old wife, Myra
Gale Brown, in 1958, it caused a sensation, though he had been legally
married in his state.
Until 1967, interracial marriage was illegal in 15 states, while sodomy
was a felony in 13 states until 2003. Marijuana is legal and openly used in
The Netherlands, while possession is a crime in the United States. Prosti-
tution is illegal throughout the United States, except for certain parts of
Nevada. There are restrictions on gambling in most states and the mini-
mum drinking age varies by province in Canada. Denitions of crimes may
differ: the level at which one is charged with driving under the inuence of
alcohol is 0.02% in Sweden, 0.05% in Japan, and 0.08% in Canada and
the United States. Comparing crime rates is problematic when denitions
of crimes differ across jurisdictions.
While crime often has a geographical focus, countries can also apply
their laws extraterritorially with regard to their own citizens. Americans
working abroad are required to continue to le income taxes with the
U.S. Internal Revenue Service, even as they might be forced to le with
their foreign country of residence. Americans, when they travel overseas for
sexual liaisons with underage foreign girls, are liable for prosecution upon
return to the United States, even if the host countrys laws allow for such
encounters. On the other hand, an American under the age of 21 legally
drinking in a foreign country is not subject to prosecution, even if they
would be if they had engaged in the same behavior in the connes of the
United States.
Immigration status can make some things criminal or may exempt peo-
ple from prosecution. Diplomatic immunity, a standard feature of interna-
tional relations, exempts foreign diplomats and their immediate family
members from prosecution by the country to which the diplomat is posted.
This is to protect foreign dignitaries from being tried on trumped-up
WHAT DOES ECONOMICS HAVE TO DO WITH CRIME ANYWAY? 3
charges. The sole recourse of the host country is to expel the diplomat
unless her country of citizenship allows for her prosecution within the host
country. This does not mean the diplomat has a free pass to commit mur-
der and mayhemindeed, she will likely nd herself prosecuted upon
return to her own country if the charges are valid.
A foreign visitor will nd himself unable to work or attend school
unless his visa permits such activity. Violating terms of his visa subjects
him to possible deportation. At the same time, ones visa status might con-
fer benets as foreign nationals who are not permanent residents are not
subject to certain requirements. They do not have to le income taxes on
their worldwide income (only the income they receive in the host country),
and can maintain multiple-spouse marriages that are legal in their country
of citizenship, and are exempt from military service in their host country.
Severity of sentencing for crimes differs from jurisdiction to jurisdic-
tion. While some states enforce the death penalty for murder, others have a
maximum penalty of life imprisonment. Even if the death penalty applies,
the likelihood that someone will be sentenced to death is far greater in
states such as Texas and Florida than in Wyoming, which, although it has
had the death penalty on the books since 1977, has only one person on
death row and only executed one other person under the revised law.
In case of this book, we use a simple denition: if it is dened as a
crime in a jurisdiction, it is a crime, regardless of whether it is legal
elsewhere.
Why Use Economics to Study Crime?

Sociological, psychological, and physiological explanations for crime are
wanting. By seeing criminals as victims of circumstances or biology instead
of as individuals capable of making rational decisions, they fall into the
blame society or blame someone else trap. Yet there are thousands of
individuals who have experienced similar difculties but have not chosen
to take action against civil society and such theories stigmatize these law-
abiding citizens. Instead of dividing society into criminal and non-criminal
elements, the economic approach to crime argues that virtually all indivi-
duals might commit a crime if provided the right motive, means, and
opportunity.
Economics does not make moral judgments or argue punishment

ought to be punitive or retributive but instead examines punishment and
other measures from the perspective of preventing future crimes. Ironi-
cally, this amoral science may be the most consistent with modern con-
ceptions of morality. By considering crime as a choice made by individuals,
its analysis is not only compatible with, but complementary to, a notion
that individuals are ultimately the sole forces responsible for their actions,
instead of arguing it was because of a broken home, defective genes, or
limited opportunity. This is not to say such factors do not cause crime
but they are not the primary reasons for it. Since economics is about
doing the best we can with the limited resources we have, it is useful to
use it in conjunction with other tools to nd the most effective ways to
reduce crime.
That some individuals may not respond to incentives and feel compul-
sions that bring into question the degree to which they exercise choice does
not mean we should abandon the economic approach. If at least some crim-
inals respond to incentives, the economic approach has value. There is also
validity to the sociological approach, suggesting we should alleviate unem-
ployment, and the psychological approach, recommending more effective
mental-health services. Unless we recognize a life of crime is a choice made
by some individuals in society, our ability to reduce crime will be limited.
Economics helps us deal with crime before the commission of the act as
opposed to just looking at the consequences after the fact. While certain
individuals may indeed suffer from reduced competence to make rational
decisions and we need to consider this in mandating sentencing for them
and others have a psychological compulsion to commit acts that cannot be
mitigated, for the most part we are not able to prevent the rst criminal act
of an individual and often cannot stop subsequent acts using alternative
approaches. Stigmatizing the poor, uneducated, minorities, males, or men-
tally ill as having criminal tendencies demonizes a population segment that
often will not commit crimes. Even if an African-American male high
school dropout is more likely to commit a crime than a college-educated
white female, that does not preclude the college-educated white female
from committing a felony nor does it mean all African-American male high
school dropouts are criminals. The vast majority of individuals in all such
designated groups in society are law-abiding citizens. So, to stigmatize
them as having criminal tendencies only encourages discrimination and

relegates many to the margins of society.
The Rational Actor Model

Economists study how choices are made under conditions of scarcity. Eco-
nomics is not about money, though how to make and allocate money to
various activities is something economists study. When a person steals a
car, bribes an ofcial, or blows up a building, he makes a choice. Since that
choice precludes other choices, conditions of scarcity exist. Economics
knows people dont have unlimited amount of time, money, or resources
but we assume people have unlimited wants and desires. Since we cannot
have all we desire, we attempt to gain as much as possible given our limited
resources. It is this focus on doing the best we can given what we have and
what we want to achieve that is the cornerstone of the rational actor
model. Economics focuses on incentives and how people react to them.
Well-dened incentives will cause behavioral changes. Poorly dened
incentives will toobut they might be ones that are unintended!
You may ask whether some individuals who commit crimes are ratio-
nal; the concept of rationality seems to preclude those who are insane.
Yet, even the insane may be rational. A person is sane when she knows the
difference between right and wrong. A person is rational when she chooses
the right way to do something based on her knowledge and resources,
regardless whether it is morally correct or deviant. A criminal acts rationally
when she enters a building at night, instead of the day, since it lowers her
chances of being caught. Even the criminally insane can behave rationally
when trying to conceal actions or hide evidence of guilt. Lacking ability to
differentiate between right and wrong doesnt preclude one from attempt-
ing to reduce the probability of capture.
Rationality has other implications as well: if criminals are rational, they
respond to punishment. The greater the punishment (or likelihood of
receiving it), all other things being equal, the lesser the crime. Many reli-
giously devout people believe in theomeny, that those who sin will be pun-
ished by God either in this life or the afterlife. This would imply such
individuals are less likely to commit crimes than those who do not believe
in divine retribution and econometric studies back up this claim.1 It also
implies when one increases punishments for repeat offenders, there is a

lower likelihood of recidivism. On the other hand, punishment com-
pression can occur, leading to unexpected consequences. Making rape a
capital offense reduces the number of rapes but increases the likelihood a
woman who is raped will be murdered because rational individuals think
at the margin.
Thinking at the margin is about incremental costs and benets. A
rational rapist facing a possible death sentence calculates the probability of
getting caught, the probability of being punished after getting caught, and
the probability the punishment will be death. The greater the probability
of the death penalty (assuming the individual views it as the ultimate pun-
ishment), the less rape will occur. Suppose one lives in a society where
rapists, when convicted, are summarily executed and we convict 80% of
the rapists. Under such circumstances, few rapes are committed. Yet, once
a rape occurs, the calculus changes. Now a rapist looks at the increase in
probability of punishment from murdering the rape victim. If this decreases
the likelihood of getting caught, the rational rapist is more likely to kill.
Moral sentiments may override the decision-making calculus. However,
this would have to be the case for a large number of rapists and morality
is not something we associate with criminals. The expression there is no
honor among thieves is a truism for a reason. When we look at criminal
behavior in the aggregate it is consistent with utility-maximizing behavior.
Whether punishment is effective depends on if it is considered a bad
thing by the individual. The movie Going in Style portrayed three senior
citizens who pull a bank heist precisely because they saw getting caught and
being placed in prison as being better than their present situations. For
them, going to prison wasnt a bad thing and its prospect actually caused
them to engage in antisocial behavior.
Present Value
Benets (and costs) accruing in the present are more readily considered
than in the future because we value the present more. Criminals have short
time horizons, tending to value present gains more than (possible) losses
associated with incarceration. To discount the future, we apply a discount
rate to our actions. How do we calculate the rate? One way is to ask: at
what interest rate are you indifferent between putting money in the bank
for one year without being able to withdraw it or having it in your hands?
This interest rate is your discount rate, r. The number of years you are
willing to wait is the time, t. We then take the Present Value (PV ), which
is the amount of money you are putting in the bank, and multiply it by
(1+r)t to obtain the amount of money you will have at time t, your Future
Value (FV ). If your interest rate is 10% and you invest $1,000, you would
have $1,100 at the end of year one, $1,210 at the end of year two (10% of
$1100 = $110, added to the $1,100 we had at the end of year one), and
$1331 at the end of year three (10% of $1210 is $121, added to
$1,210 gives us $1331):
FV = PV(1+r)t = $1,000(1+0.1)3 = $1,000(1.1)3

= $1,000(1.331) = $1,331
Alternatively, we can solve for present value:
PV = FV/(1+r)t
Thus:
PV = $1,331/(1+0.1)3 = $1,331/(1.1)3 = $1,331/1.331 = $1,000
Criminals may have a higher interest rate than the rest of us. They do,
after all, go to loan sharks more often, who charge much higher interest
rates than banks.
Limitations of the Economic Approach
Economists do not examine why or how people choose. We look at what

choices are made and how changing incentives alters those choices. Chang-
ing the penalty or its probability has an effect on the number of crimes
committed. Raise the cost of committing crime and you lower its
incidence.
Economists do not concern themselves with how people arrive at a deci-
sion. Crimes of passion or opportunity are, by denition, not thought out
in advance. The consequences are not completely calculated. Yet, these are
instances of maximizing benets or minimizing costs, two sides of the same
coin. In a crime of passion, the individual disregards the punishment that
will accrue to them as their concern is with short-term consequences.
Attempting to kill or cause bodily harm is the goal and the way an econo-
mist approaches the problem is to see if it was achieved with the minimum
possible short-term cost. Crimes of opportunity, like picking a pocket or
stealing a briefcase left in the open, are conducted to minimize possible
detection or maximize potential gain. Thieves steal from those who are
well-dressed (assuming they have fatter wallets) but also those who are not
paying attention (easy marks). They maximize benets or minimize costs,
even if they might regret the decision later. We will use the term rational
behavior to mean benet-maximizing or cost-minimizing behavior.
Economics examine broad public policy implications, not any one
persons actions. Raising the ne for exceeding the speed limit will not stop
everyone from speeding. However, the total number of speeders will
decline, even if some do not choose to slow down with higher nes. Pre-
tend you are late for a meeting and if you do not arrive on time you lose
$20. You cannot make it to the meeting if you do not speed and you will
make it to the meeting if you do. You have a 10% chance of getting caught
and, if caught, you will be late for your meeting and will be ned $100.
Will you speed? You might gure with a 10% chance of getting caught and
a ne of $100, it is better to speed since 10% of the time you lose $120
(the ne plus the $20 for being late). On average, you expect to lose 10%
$120 = $12. That is better than losing $20 for certain, isnt it? What if
the ne were raised to $10,000? Now you better not speed. Similarly, if the
meeting is more important, you will be more likely to speed. What about if
the chance of getting caught were lowered to 5%? Raised to 90%?
Wont these cause changes in behavior?
There should be some point where anticipated cost equals anticipated
benet. Perhaps it is at a ne of $180 and a 10% chance of getting caught
versus the $20 you lose if late for the meeting. Any ne above this level will
cause you not to speed. Any ne below will cause you to speed. We call this
the indifference point and say you are at the margin. Being at the margin
means you are indifferent between action and inaction. Altering the ben-
ets or costs will cause a change in behavior.
Of course, some individuals would never commit certain crimes under

any circumstances. Their moral code imposes an innite cost for those
actions and it would be irrational for them to commit those crimes. Sim-
ilarly, some individuals will commit certain crimes regardless of the cost
imposed by society. Their benets may be considered innite. This
doesnt disprove the economic approach. The key is whether some indivi-
duals are inuenced by the degree of the penalty.
Economics cannot be applied in a vacuum. A very effective way to
reduce theft is to cut off a thiefs hand. Similarly brutal punishments can
be implemented for sex crimes. But civilized societies have determined
such punishments are cruel. Economics must be considered in conjunction
with, and not as a replacement for, other approaches.
Benefits of the Economic Approach
Rather than looking at how individuals differ in nature or environment,

economics looks at how individuals differ in choices made. Instead of clas-
sifying people into criminals and law-abiding individuals, economics rein-
forces the concept we are all on a continuum between these two extremes.
Economics addresses how government and private individuals alter such
behavior. While sociological, psychological, and physiological approaches
help us to understand why criminal activity occurs in individuals, the latter
two approaches do not help us alleviate this activity beyond a specic indi-
vidual and the rst provides only broadly applicable policy prescriptions.
The economic approach is particularly useful for transactions involving
voluntary exchange of illegal commodities but it works well for those
which are nonmarket-based as well.
Opportunity Cost
Opportunity cost is the value to the person of the next best alternative not
undertaken. In considering non-trivial actions, it is typically the most prev-
alent cost for an individual.
How does opportunity cost enter into the question of analyzing crime?
There are at least three ways we use this concept. First, we look at choices
individual criminals make. Suppose you are a criminal. You can choose to
steal one of the two reasonably new Honda Accords but not both. The rst
car has keys in the ignition, the second car is locked and the driver has used
a steering wheel immobilizer device. Which car is more likely to be stolen?
Obviously it is the one with the keys in the ignition. The cost of stealing a
car in terms of lost time and potential effort is much higher when the car is
secured. Does this mean the secured car will not be taken? No. However, if
there are easier or more protable targets available, the likelihood of theft is
reduced by these actions.
Second are choices individuals and rms make to prevent or mitigate
crime. Every dollar spent and each hour of time undertaken to secure one-
self against crime is money and time not spent doing something else. When
my daughters were young and we lived in Jamaica, I had an alarm system
and burglar bars in my home but did not purchase a gun. The alarm system
and bars were relatively minor costs relative to the chance of theft. However,
a gun with two small children has a very high opportunity cost. If one of my
daughters had come upon the alarm and accidentally triggered it, the alarm
company will send armed response to investigate. If one of my daughters
accidentally found my rearm, consequences would be far more serious.
Given I am prone to being forgetful, I realized the possibility of such an
occurrence is higher than with other individuals, so I rationally decided
against a rearm at the time (that it is almost impossible to procure a rearm
legally in Jamaica may also have played some role in my decision).
We can also look at the choices governments make to combat crime.
Crime prevention is a protection mechanism that attempts to secure already
created goods but every dollar we spend on crime prevention is a dollar we
cannot spend on good or service creation. We trade additional goods and
services for more protection. A city or state that spends more on crime pre-
vention must spend less on something else, such as schools, roads, or sewage
treatment, or must tax its citizens more heavily, which reduces consumption
of private goods and services, such as groceries, gasoline, or amusements.
Choices once made open up possibilities and close off others. A person
with a job is usually less likely to engage in crime due to fear of losing that
job. However, holding certain types of jobs (such as auditor or CEO of a
major corporation) allows one to engage in criminal activity that someone
who lacks such a job would not be able to do. Barry Minkow, founder of
Zzzz Best Carpet Cleaning Company, pled guilty to securities fraud
violations in connection with falsifying revenue on corporate statements,

but he only could commit the crime because of his position.
None of this implies an absence of morality. Moral compunction plays
a role in how people act. Persons with an avowed moral code refrain from
certain nefarious behavior simply because it is repugnant to their moral
psyche. This too qualies as an opportunity cost. Recently I had occasion
to return to a store when I discovered an item I purchased was not listed on
my receipt. While the act was not one of pilfering, but instead lay in a
clerks mistake in failing to scan the item, I felt a moral imperative to return
and ensure payment was properly remitted. This was a rational decision
because otherwise I would have faced mental anguish over not having done
the right thing.
Actions undertaken to satisfy the honor code of a profession, such as a
priests vow against sigilism, the act of revealing what is said during a con-
fessional, could lead to unfortunate consequences even as it upholds a
larger principle in the priests mind. Breaking condentiality may lead to
parishioners reluctance to engage in the sacrament. Not honoring patient
or client condentiality by medical doctors and lawyers could lead to con-
sequences much graver in the long run than would be gained by society by
having them break their oaths. Yet some priests, doctors, and lawyers have
decided to reveal these secrets despite repercussions for themselves and
their fellow professionals because they believed the benet from doing so
outweighed the cost.
Since an individuals opportunity cost is personal and known only to
that individual, an outside observer cannot determine in advance whether
an action will occur. All we know is if someone is willing to act when her
opportunity cost is low, she might be less willing as her opportunity cost
rises. If opportunity cost is high, her reluctance to act may be alleviated by
a reduction in this cost. People are more willing to turn states evidence and
assist the prosecution when costs are lowered or benets are raised.
Marginal Analysis
When economists talk about how people make decisions, they use one of
two models: the rst is marginal analysis and the second is institutional
analysis. We will defer our discussion of institutional analysis until later in
this chapter and instead discuss the decision-making method most often
taught in introductory economics: marginal analysis.
People make decisions by weighing costs and benets at the margin.
The margin is the decision you make on whether to buy an additional unit
of something or not. Suppose you are the Superintendent of Public
Instruction for the local school district. There are three schools in your
school district and librarians at each school are complaining about book
theft. You cannot give them additional money but they have a solution to
reduce costs without increasing the budget. Indeed, they promise to
increase spending on new books, a goal high on your agenda as Superin-
tendent. Each year, the high school in your district experiences $5,000 of
book theft, while the junior high loses $1,000 of books to theft, and ele-
mentary school book theft costs $500. The librarians want you to purchase
an anti-theft device from a local rm to theft by 90%. It will cost $900 per
school per year with no discount for multiple schools. The librarians tell
you this is a very good deal because you will reduce losses from $6,500 to
only $650, a savings of $5,850 at a cost of just $2,700. That means an
extra $3,150 a year for purchasing new books.
It is a good deal until you realize you can do better: only install the
system in the high school! That saves $4,500 on theft for only $900, giving
you an extra $3,600 for purchasing new books. At the junior high, benets
(reducing theft losses by $900) equal costs. You also wont install at the
elementary school, where it will cost $900 but only reduce theft losses by
$450. Sometimes preventing crime isnt worth it.
Supply and Demand

Supply and demand refer to a price schedule spelling out the amount of a
good people are willing to sell (supply) or purchase (demand) at a given
price. We determine these schedules by looking at all individuals in a mar-
ket and asking the minimum price they are willing to accept as payment to
offer a good (supply) or the maximum amount they are willing to pay for a
good (demand).
As price rises, people are willing to sell more and as price falls, people
are willing to buy more. Quantity supplied increases with price and quan-
tity demanded falls with price.
Economics use graphs to illustrate supply and demand. We begin with

a demand schedule (Table 1.1) representing those quantities buyers are will-
ing to purchase at varying price levels for crack cocaine on any given day in
a hypothetical major metropolitan area:
Table 1.1. Quantity Demanded of Crack Cocaine

Quantity demanded Price paid
(in ounces) (in dollars per ounce)
15,000 50
10,000 100
8,500 150
7,500 200
6,000 250
5,000 400
2,500 500
The supply schedule (Table 1.2) showing the hypothetical quantities

sellers are willing to sell at varying price levels is based on the cost for the
seller:
Table 1.2. Quantity Supplied of Crack Cocaine

Quantity supplied Price received
(in ounces) (in dollars per ounce)
2,500 50
5,000 100
6,000 150
7,500 200
8,500 250
10,000 400
15,000 500
We can combine these two schedules into one schedule (Table 1.3)
and determine that the price where quantity supplied equaled quantity
demanded is $200 and there were 7,500 ounces purchased at that

price:
Table 1.3. Supply and Demand of Crack Cocaine

Price
Quantity Price paid Quantity received
demanded (in dollars supplied (in dollars
(in ounces) per ounce) (in ounces) per ounce)
15,000 50 2,500 50
10,000 100 5,000 100
8,500 150 6,000 150
7,500 200 7,500 200
6,000 250 8,500 250
5,000 400 10,000 400
2,500 500 15,000 500
Still, a picture is worth a thousand words (or a lengthy table). By graph-

ing the two schedules (Figure 1.1), we can visually represent the aforemen-
tioned table and present the information in a much easier manner to
digest:
$500 S
$400
$300
Price
$200
$200
$100
7,500 D
$0
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
Quantity
Figure 1.1. Supply and demand of crack cocaine.

The price where quantity supplied equals quantity demanded is called

the equilibrium price and it is $200 in this example. However, while, in
most markets, the price paid by buyers is very nearly the same as the price
received by sellers, this is not the case in illegal markets. The difference
between what the seller receives and what the buyer pays is a transactions
cost and represents the cost to the buyer (or the seller) of engaging in the
transaction. Examples of transactions costs include commissions and taxes
paid for legal transactions and bribes and costs of avoiding police capture
for illegal transactions.
Suppose there is a transactions cost of $100. This is the difference
between what the buyers pay and the sellers receive. In that case, we can
shift the supply curve up by $100 or shift the demand curve down by
$100 (but not both) to reect this transaction cost. In Figure 1.2, you will
see the revised graph and in Table 1.4, the revised table.
Making something illegal and imposing a transactions cost reduces
quantity demanded of the good, increases price paid by buyers, and
decreases what sellers receive.
Changes in Demand
The price of the good is the result of the interaction of the supply and
demand schedules. Quantity sold is likewise determined by this
$600 S1
$500 S0
$400
Price
$300 $250
$200
Transaction
$100 Cost = $100 6,000
D
$0
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
Quantity
Figure 1.2. Supply and demand of crack cocaine with a $100 trans-
sactions cost.
Table 1.4. Supply and Demand of Crack Cocaine with a $100 Trans-
sactions Cost
Quantity Price paid Transactions Amount received Quantity
demanded by buyer Cost by seller supplied
(in ounces) ($/ounce) ($/ounce) ($/ounce) (in ounces)
15,000 50 100 50 0
10,000 100 100 0 0
8,500 150 100 50 2,500
7,500 200 100 100 5,000
6,000 250 100 150 6,000
5,000 400 100 300 9,250
2,500 500 100 400 10,000
interaction. The demand and supply schedules are simply schedules that
hold everything else constant except for price. They show how quantity
demanded or supplied will change in response to changes in price. But
what determines the demand and supply schedules? In other words, what
determines demand or supply other than price? We will begin by examining
demand. In addition to transaction costs discussed earlier, we will look at
six basic, though non-exhaustive, factors that determine demand: prefer-
ences, income, prices of related goods, anticipated changes in quantity,
number of participants, and the demand for output goods.
First, though there is some dispute in economics over this since many
economists argue preferences cannot change (discussed further in the sec-
tion on rational addiction), there are the preferences (or tastes) of con-
sumers and suppliers. Changes in fashion, age distribution of a population,
advertising, or any of a myriad of things cause a change in the desirability of
a product or service. When something is made illegal, this may drive people
to desire it, especially if the perceived chance of being caught is low. In
such cases, we see an increase in both the price and the quantity sold
(Figure 1.3).
Second, there is income. As income changes, so does demand for var-
ious products. Demand to an economist is effective demand as opposed to
simple desire. It must be coupled with wherewithal to purchase. A drug
addict may prefer, if the price were the same, the crystal form of
Price
D1
D0
Quantity
Figure 1.3. Increase in demand.
methamphetamine, which is higher in purity, to powdered methamphet-

amine but lacks the ability to purchase it. She, therefore, purchases the
powdered form. When her income rise, she moves on to crystal meth,
reducing her consumption of powdered meth. Goods for which demand
increases with increases in income are normal goods, and goods for which
demand decreases with increases in income are inferior goods. While infe-
rior goods are often of lower quality, this is not really part of the denition
and may not be true. Things can also get a little difcult when one tries to
apply the denition. Crime falls with income but is this due to the change
in income or the change in the price? The price of committing crime rises
with income as jail time has a higher opportunity cost for the wealthy (due
to higher loss of income) than for the poor. It is only when the punishment
for the infraction is paid exclusively by ne and does not require a court
appearance that the cost is the same for both the rich and the poor. The
cost of a parking ticket is the same for both rich and poor but the cost of
murder is appreciably higher for the wealthy. While these are described at
the individual level, if the general level of income rises or falls, we will see
these changes reected in overall demand. If we are dealing with an inferior
good and the overall level of income rises in a society, we will have a
decrease in demand (Figure 1.4).
Third, there are prices of related goods. Both marijuana and hashish are
made from the cannabis plant and have similar physiological reactions.
Price
D0
D1
Quantity
Figure 1.4. Decrease in demand.
Individuals reasonably see the two goods as competitors for their funds. If
we raise the price of hashish relative to marijuana by increasing penalties for
hashish while leaving penalties for marijuana possession unchanged, we
will see an increase in the demand for marijuana as hashish users switch.
Marijuana and hashish are substitute goods. As the price of one good rises,
demand rises for the good that does not change in price. Complementary
goods are goods with the property that as the price of one good rises,
demand falls for the good that does not change in price. This is usually
because the two goods are consumed together. Thus, hashish and tobacco
are complementary goods because hashish is often smoked in combination
with tobacco to mitigate its increased potency when compared with mar-
ijuana. A rise in the tobacco tax lowers demand for hashish (and, by exten-
sion, raises demand for marijuana, so raising cigarette taxes increases
marijuana consumption). Just because two goods are complementary
goods does not mean one can decide to raise the price on either good with
equal effect. Guns and bullets are complementary goods but doubling the
price of bullets is likely to have a different impact on gun sales than dou-
bling the price of guns. Increasing the cost of a good only affects its future
sales. If you want to decrease sales of bullets to existing gun owners, you have
to increase the price of bullets and not guns. With legal goods, increasing
the price of a complementary good is not as effective as raising the price of
the good itself. When looking at illegal goods, however, it is more effective
to limit the sales of those legal, but complementary, goods because
regulating sales of legal goods is far easier than regulating sales of illegal
goods. Since the decongestant pseudoephedrine can be made into meth-
amphetamine quite easily (no, I am not going to tell you how to do it), the
law has strict limits on the quantity of decongestants containing pseudo-
ephedrine that individuals can buy.
Fourth, there are anticipated changes in quantity or quality. When
something is to be made illegal, demand often shoots up. President Kennedy
reportedly sent Pierre Salinger, his press secretary, out to secure Cuban cigars
immediately prior to imposing the Cuban trade embargo in 1962. In the
early 1980s, the development of crack cocaine, a derivative of greater potency
and purity that delivered a nearly instantaneous high, likely increased
demand for cocaine in general.
Fifth, we can look at the number of participants in a market. Immi-
gration and births will increase demand for goods while emigration and
deaths decrease demand.
Sixth, there are prices of output goods. If a good is used in the produc-
tion process, it is affected by demand for all goods created from that good.
The cannabis plant is used to make both marijuana and hashish. Suppose
marijuana and hashish are legalized. This would cause the price of mari-
juana and hashish to fall and demand to rise. Demand for goods used in
the production process will rise. That means demand for cannabis plants
will rise. This type of demand is known as a derived demand since people
do not purchase cannabis plants except to produce marijuana or hashish,
unlike other goods that have a value to the consumer from the product
itself. Supply and demand depend on the perspective we are taking. Pro-
ducers of marijuana demand cannabis plants and supply marijuana, while
producers of cannabis plants demand seeds and supply cannabis plants.
Changes in Supply
Supply is affected by the following factors: number of suppliers in a mar-

ket, prices of input goods, technology, and taxes. As suppliers increases in a
market, supply shifts outward. Given a xed demand curve, price
decreases. Additional prostitutes entering the market for prostitution
depress prices due to competition and increase the quantity of sex sold.
This is manifested by an increase in supply (Figure 1.5).
S0
S1
Price
Quantity
Figure 1.5. Increase in supply.
S1
S0
Price
Quantity
Figure 1.6. Decrease in supply.
Similarly, when prostitutes are arrested, supply of prostitutes will

decrease, causing a rise in the price changed and a reduction in quantity
of sex sold (Figure 1.6).
We have shifted the supply curve to the right and the left and the
demand curve to the right and the left, calling these alterations increases
when the movement of the relevant curve is to the right and decreases
when the movement is to the left. Another way to think about supply curve
shifts is to consider production cost changes. Increases in taxes or the cost
of input goods (such as cannabis plants) that cause the production cost to
increase result in an upward shift in the supply curve. Better technology or

decreases in taxes or the cost of input goods that cause the production cost
to decrease result in a downward shift in the supply curve (Figure 1.7 and
Figure 1.8).
Making a good illegal tends to steepen the demand curve and make it
more inelastic. That means increases in price due to efforts to control them
via policing, nes, and other mechanisms have less of an impact on
demand for these goods than for legal goods.
S1
S0
Price
Quantity
Figure 1.7. Increase in cost of production.
S0
S1
Price
Quantity
Figure 1.8. Decrease in cost of production.

Institutional Analysis
Up to now I have emphasized the individual as an autonomous agent in
society. But what about society? Doesnt it have a role to play in determin-
ing the level and extent of crime? Absolutely. In economic theory, institu-
tions provide the legal and social framework within which individuals act.
Thus they provide constraints and incentives that work on individuals to
advance common aims. Society is not merely the sum total of individual
preferences: it has a historical legacy and there are certain dening charac-
teristics about societies that make it easier or more difcult to affect change.
According to institutional economics, within each society, there are
several institutions, religious political, social, and education to name a few,
which dene and alter preferences in individuals. Advertising, for example,
acts to redene wants to make individuals desire things that they have not
had before. This approach is in contrast to the neoclassical economics claim
that preferences are static. This distinction is a sharp distinction between
institutional economics and neoclassical economics, the dominant school
of thought in economics and which we spend the better of this book
describing.
Institutional economics examines how organizations change and how
individuals both react to and precipitate those changes. Instead of
individuals deliberating over a decision, making it as a result of a clear
calculus of the benets and costs, institutional economics supposes that
individuals display only bounded rationality: the world is too complex to
handle all possible solutions so that only some are considered and analyzed.
We can accommodate this criticism within a neoclassical framework. Cog-
nition takes time and effort so we economize on it when it is not worth-
while to engage in such tasks.
Institutions also affect behavior by altering property rights and thus
both the distribution of income in a society and the decisions individuals
make. Property rights might legitimize past illegal behavior (the Kennedys
were not forced to give back bootlegging prots after Prohibition ended) or
they might force certain individuals to begin life with a limited endowment
(freeing slaves after the Emancipation Proclamation did not give these indi-
viduals claim to the goods and services of their former masters). Each of
these institutional changes will create a different society: more able to react
in certain circumstances; less able in others. Certainly, the decisions the

Kennedys can make given their past gains are markedly different from
those available to the grandson of a sharecropper who never received his
promised 40 acres and a mule. Efciency cannot be abstracted from its
institutional environment. We often take for granted that a particular dis-
tribution of property rights is correct and proper, the best possible world in
which we live. This is simply not the case. Optimization takes place within
the sphere of a property rights regime and it is entirely possible we would
be better off with a different set of laws but are unable to know without
altering the legal landscape.
The fact institutions matter was shown in the Stanford Prison Exper-
iment of 1971. Students were divided into two groups: prisoners and
guards. Even though it was an experiment and not a real prison, individuals
quickly adopted postures more consistent with actual prisoners and guards
in a prison environment. Similarly, the 1963 Milgram experiment suppos-
edly tested the validity of punishment on memory. Instead it was an exper-
iment on obedience. A participant was asked to deliver electric shocks to
actors hidden behind a wall and increase their intensity every time an
incorrect answer was given. As the shocks increased in voltage, the actors
began rst to plead for them to stop and then they screamed in agony.
When participants questioned whether they should continue to increase
the voltage, the experimenters told them that everything was alright and
nearly two-thirds of the participants ended up agreeing to administer what
would have been fatal levels of electric shocks. Social conditioning is a
powerful motivator.
Institutional analysis brings into question moral, philosophical, and
ethical issues that are not found in neoclassical economics. Its concern with
dening an institutional matrix that provides the best possible solution to
todays problems is a broader conception than economics traditionally
allows. However, it tends to complement as opposed to replace the neo-
classical analysis we provide. Societies that preach control and obedience
have better luck controlling crime than those that do not but this is to be
expected from using the economic approach to human behavior. After all,
such societies are merely increasing the benets of compliance and raising
the costs of non-compliance. Rationality would dictate the effect of such
actions would be to reduce criminal activity.
Economics in the neoclassical tradition is about doing the best we can

within a legal framework or about making incremental and marginal
changes to existing law. It isnt about wholesale alternation of the under-
lying institutional structures of society. Some societies will simply be safer
because of their underlying nature but safety from criminal activity is
granted often by a corresponding reduction in liberty. Economics is inca-
pable of dictating what that balance ought to be. It can only inform us as to
the costs and benets of each approach, leaving to us the difcult decision
as to whether such sacrices are worth the resultant reduction in crime.
For the Economist: Indifference Curves and Crime

In this section, I assume you have an understanding of indifference curves.
If you do not, you may freely skip it. Most standard textbooks provide
examples of when one has an economic bad and an economic good. One
will accept more of the economic bad, only if one receives more of the
corresponding economic good. Pollution and transportation as well as
income and work may serve as examples of such tradeoffs. Both result in
upward sloping indifference curves and the direction of preference line
always points towards the economic good and away from the economic
bad, meaning we want more of the economic good and less of the economic
bad (Figure 1.9).
Pollution
Direction of
preference
Transportation
Figure 1.9. Indifference curves between pollution and transportation.

We can also look at the choice between two economic bads. Some
individuals derive utility from engaging in violations of societys norms.
Conformity to civil society is an economic bad for them. Similarly, pun-
ishment is undesirable as well.
If we have two economic bads, punishment and good behavior, the
direction of preference points inward towards the origin. What may not
be clear is these bads also have corresponding goods, reward and bad
behavior, for the criminal. We can actually represent all four possible com-
binations (punishment/good behavior, punishment/good behavior,
reward/bad behavior, reward/bad behavior) on an indifference map that
represents each of the possibilities in a different quadrant (Figure 1.10)
The indifference curve for the two economic bads is concave. We
rotate the previous diagram 180 degrees and eliminate the quadrants not
applicable to the two economic bads for the criminal to arrive at the fol-
lowing, a series of concave indifference curves, instead of convex, and with
the direction of preference moving inward (Figure 1.11).
The budget constraint normally limits us from going to higher indif-
ference curves but, in this case, it stops us from getting to lower indifference
curves that provide more utility. We have a budget constraint of punish-
ments and rewards used by society to increase good behavior and reduce
crime. The slope of the budget constraint is the persons tradeoff between
Reward
Good behavior Bad behavior
Punishment
Figure 1.10. Indifference map.

Punishment
Good behavior
Figure 1.11. Indifference curve for two economic bads.
P*
Punishment
G*
Good behavior
Figure 1.12. Determining optimal punishment.
punishment and greater good behavior. The optimal choice for punish-
ment (P*) and good behavior (G*) is derived where the budget constraint
touches the lowest indifference curve (Figure 1.12).
Raising sentences will cause an outward shift of the budget line whereas
making them more lenient will cause them to shift inward. However, alter-
ing the sentence so as to reduce the credit individuals receive for good
behavior will cause a rotation of the budget constraint in a manner consis-
tent with altering the slope without altering the vertical intercept. While
both will unambiguously reduce crime, raising sentences will reduce it
more for some criminals, while altering the tradeoff will reduce it more for
others.
Questions for Review

1. If some people are irrational, does this mean that the economic
approach to crime is useless?
Absolutely not! Irrationality means simply individuals do not respond to
incentives and disincentives. Incentives and disincentives would be useless
only if everyone behaved irrationally. So long as some individuals are
rational, the economic approach to crime has the potential for lowering
crime rates.
2. Suppose that the law against speeding were no longer enforced. What
would happen to average speeds on the freeway? What about if the
police took a zero-tolerance rule toward speeders and they used photo
radar?
If the police failed to enforce laws against speeding, speeding and average
speeds on the highway would increase. If this were not the case, the law
would be ineffective. A law that sets the speed limit at 200 mph would be
ineffective because no one drives that fast (we would hope!). However,
enforcing a speed limit at 50 mph on the freeway would reduce average
speeds. Therefore, if one were to stop enforcing the law, one would expect
average speeds would increase (but not by as much as if the law itself were
abolishedsome people will follow the law simply because the law
exists). Similarly, if police took a zero-tolerance rule towards speeders and
used photo radar, we would expect a reduction in average speeds.
3. (a) In 1934, the kidnapping and death of the Lindbergh baby caused a
major change in the law. Prior to that date, kidnapping in New Jersey
was a misdemeanor and there was no federal law on the books. After
that case, the federal Lindbergh Law provided for the death penalty
for kidnapping that caused the transportation of the victim across state
lines or for which the ransom note was sent via the U.S. mail service.
What do you think was the impact of the law on the number of kid-
nappings? What about murder of kidnapping victims?
The kidnapping rate dropped dramatically but the percentage of kidnap-
ping victims who were subsequently murdered by their kidnappers rose.
(b) In 1968, the Supreme Court of the United States invalidated the
death penalty in such cases. What do you think happened to the num-
ber of kidnappings? What about murder of kidnapping victims?
It went up but the percentage of kidnapping victims subsequently mur-

dered went down. In 1997, according to the National Incident-Based
Reporting System, only 1 murder of a juvenile kidnapping victim was
recorded out of 1,214 kidnappings in the 12 states participating in the
system3.
4. What happens to the crime rate if we eliminate parole and impose
mandatory sentencing? What about the cost of achieving that crime
rate? What about good behavior? Use indifference curves in provid-
ing your answer.
Elimination of parole, coupled with mandatory sentencing, effectively
makes the budget line a horizontal one at the point where the punish-
ment is determined. While eliminating parole and providing mandatory
sentencing reduces the crime rate, it does so in a less effective manner than
judicious use of parole because we end up with a corner solution. Since
parole reduces costs dramatically (parole costs roughly 1/10th the cost of
prison), costs will probably increase and good behavior decline precipi-
tously. By increasing sentences but maintaining parole, we achieve the
same rate of criminal activity at lower cost (Figure 1.13).
Punishment
Good behavior
Figure 1.13. Graphical solution for question for review 4.
Questions for Discussion

1. How would an economist respond to someone who claims that the
only acceptable amount of crime is zero?
2. Suppose marijuana were legal. Would this increase or decrease its

consumption?
3. The author claims changing the slope of the supply or demand curve
can cause an increase or a decrease in quantity demanded or supplied
and the direction of change will depend on the specic price of the
item. Thus, at high prices, one might see an increase (or decrease)
while at low prices, one might see the opposite. Using a supply and
demand graph show this and explain why such an alteration in slope
might occur. Why might this be important from the standpoint of
studying the economics of crime?
4. What happens when we require sentences to be fully served but
reduce the time served because of prison overcrowding? Use indiffer-
ence curves in providing your answer.
5. In China, authorities can sentence someone to a suspended death
sentence, to be carried out if the person fails to exhibit good behavior
in prison. If the prisoner exhibits good behavior the sentence is com-
muted to life imprisonment. Discussing whether sentencing some-
one to death with the hope for commutation, in a manner similar
to what occurs in China, would improve the behavior of those on
death row.
CHAPTER 2
Are Criminals Rational?

Gary Beckers Rational
Criminal Thesis
A criminal breaks into your home and steals something. You, of course, are
upset but the impact on the overall economy is nonexistent. The sole effect
is a resource transfer from you to the burglar. Property crimes can be
thought of as transactions without tradethey are pure transfers of wealth
from one person to another and are, at least in some fashion, no different
from taxing one individual (the victim) to pay another (the criminal).
However, crime does not exist in a static vacuum. Repercussions of crim-
inal activity lead individuals to expend resources to prevent or mitigate it.
People might install burglar alarms, hire a security company, purchase a
weapon for protection, or purchase insurance. To the extent an individual
seeks to protect himself from crime, it represents a net decrease in the
overall welfare of societyexpend resources to protect wealth increases
neither wealth nor utility.
Most people will experience several property crimes during their life-
time. Even in areas that rarely experience murder, incidents of property
crime are rather common. Property crimes are more likely to be committed
not against wealthy individuals but against those least able to protect them-
selves: the poor and minorities.
Those who fail to take precautions are more likely to be victimized.
Criminals look for easy targets and go after those who are not paying
attention. Leaving your car doors unlocked is an invitation to thieves to
steal your car or at least things inside of your car. Even worse is to leave the
keys inside the car. In fact, 20% of all stolen cars are not hotwiredthey are
driven off using the owners keys.
Precautions are not created equal. Some actions (taking ones keys,
locking ones door) merely redirect the thiefs attention elsewhere. It
reduces the probability you will be the victim but does little or nothing to
prevent crime for society. The thief just looks for the easier target. Some
actions are undertaken to increase the likelihood of arresting the indivi-
duals responsible (having Lo-Jack installed). Since the thief increases the
likelihood of being arrested when he steals a car with a system that tracks
the location of the car once activated, this will reduce crime for everyone.
Actions that pay for losses, such as insurance, actually increase crime for
society since once you buy insurance, the insurance company faces the
problem of moral hazard. Once insured, you will not think as much about
taking your keys or locking your door.
From a business perspective as well, criminals look for opportunities.
Distracted salesclerks, labels that can be easily switched, restrooms, and
changing rooms, all provide opportunities to pilfer. But most theft comes
from employees, who know how to defeat the security measures and have a
greater opportunity and access to cause mischief.
Crime as a Rational Decision

Economists make certain behavioral assumptions. The rst assumption is
that people engage in a pleasure/pain calculus called utility maximization.
Economists use the term utility to describe a method to measure how
effectively an individual achieves his goals. Higher degrees of utility mean
more satisfaction. It is assumed individuals would desire to maximize the
amount of satisfaction they have, so we consider this type of modeling of
human behavior to be a utility maximization model.
Given a choice between two possible outcomes, the person will log-
ically choose the one that derives the most satisfaction (or avoids the most
dissatisfaction). Such a model is consistent with virtually all types of
human behavior: if offered a choice between $10 and $20, how many
of us would choose $10? If offered a choice at a buffet, who among us
would not eat that which we enjoy the most? At the same time, when
there are costs involved, we weigh these costs when making our decision.
Jennifer really likes to eat lobster, so at a buffet, when this choice is
offered, she will choose to have some over, say, tuna, which she enjoys
GARY BECKERS RATIONAL CRIMINAL THESIS 33
less. On the other hand, if she were to have to pay $20 for a pound of
lobster versus $4 for a pound of tuna, she might very well choose the
tuna. She prefers having $16 and a pound of tuna to having no money
and a pound of lobster.
So why is it when she goes to the buffet, you will see her eating both
lobster and tuna? That is due to the law of diminishing marginal utility. At
some point, the more lobster she has, the less she values having more of it.
She will consume lobster only to the point where the next piece of lobster is
equivalent in value to her of something else.
This diminishing marginal utility principle is another important
assumption in how economists view the world. If it were not true, Jennifer
would simply eat lobster and nothing else. Since Jennifer does not do that,
economists reason she nds something else more appealing after having
enough lobster.
As marginal utility diminishes, it has important implications on the
slope of the demand curve. In order to convince someone to purchase
more, the price must be lowered at least on the next unit to be purchased.
This is one rationale for giving quantity discounts. Even for individuals
who would never purchase two items at full list price, few are those who
will balk at the notion of buy one, get one at 50% off. The cynic might ask
why the product isnt sold at a 25% discount in this instance but the rea-
soning is that such promotions will not necessarily work as well. After all, if
the price is reduced on all items, the customers might choose not to pur-
chase the second item at all, potentially leading to lower overall sales and
lower prots. Fewer individuals will still decide to forgo the offer of buy
one, get one free by declining the free item, although the rationale of not
reducing the price has less validity in this case unless the marginal cost of
providing the second item to the same individual is lower than selling it to
someone else. Instead it is so that we can denitely sell two rather than just
one. Still, this is oftentimes a marketing gimmick since you can usually pay
half price for one item in such cases.
What does all of this have to do with crime? Well, if all individuals are
rational in seeking to maximize utility, criminals must do this as well. Most
policies regarding criminality are predicated on the assumption everyone is
rational and respond by pursuing activities less when punishment is
increased and more when rewards are increased. Think back to the year
1985. In order to counterfeit a bill, you still had to have your own printing
press and engrave your own plates. Well, suppose you are contemplating
making and passing a counterfeit bill. Which bill will you choose to coun-
terfeit: a $20 bill, a $10 bill, a $5 bill, a $2 bill, or a $1 bill? The obvious
answer is the $20 bill. There is no greater risk of detection (at least not in
1985 when all bills were essentially the same but for the denomination)
and the rewards are higher. Counterfeiters generally try to counterfeit the
$20 bill as opposed to other denominations because of its high value and
wide acceptance (higher denominations generally invite greater scrutiny or
may not be accepted by businessesthis did not mean that higher
denominations were not counterfeited as well but lower denominations,
especially the $1 bill, were not). What happened when the government
spent more money to try to defend the $20 bill by introducing color-
changing watermarks and embedded strips that identied the bill? All of
a sudden there was a urry of activity to start counterfeiting the next most
widely accepted bill: the $10 bill. Yet you will notice something else about
the bills in your wallet. Take a look at a new $1 bill and one from 1997 or
earlier. Now do the same for any other denomination. While the other
denominations have changed (the most obvious feature is that the picture
of the president is now larger and more off-centered), you will see that the
$1 bill has not changed at all! Why is that? Well, think about it. There is
very little to be gained by counterfeiting a $1 bill: the cost of producing a
counterfeit bill mostly lies in its paper (in fact, it is made of a special cloth-
like paper that resists tearing and is available exclusively to the U.S. gov-
ernment) and much of that paper comes from bleaching $1 bills prior to
printing over them with higher denominations. This is one reason why
bills now have a running strip in them with the denomination spelled out.
These are located at different positions in the bill itself, depending on the
denomination that was originally printed, and cannot be seen unless held
up to the light.
That doesnt mean the government wont put security features in the
$1 bill eventuallyit just wont introduce them rst into this denomina-
tion. After all, even casual counterfeiters (who typically use photocopiers or
laser printers) dont counterfeit the $1 bill due to the cost of color ink (the
one ominous exception are teenagers who use the parental computer to do
soafter all, they arent paying for the ink!).
What about other theories of criminal behavior? Many people initially

think if one theory is correct, other theories must inherently be wrong but
this is not the case. Economic theory focuses on choices people make given
certain preferences. The other major theories of criminality can be grouped
into one of three categories: physiological, psychological, and socioeco-
nomic. Physiological theories examine the propensity for aberrant behavior
as a result of chemical or chromosomal differences. Individuals with certain
chemical imbalances in the brain and those who have chromosomal abnor-
malities (such as being an XYY chromosome male) may be more suscep-
tible to antisocial behavior. Psychological theories look at how mental
illness plays a role. Socioeconomic theories look at the role that broader
society has in modifying behavior. Members of a cult may be indoctrinated
into a set of beliefs that are contrary to those found by others in society.
Those who are relatively wealth-deprived may be more susceptible to crim-
inality than those who are of average or above-average income. Socioeco-
nomic explanations and economic explanations are often approaching the
same question from slightly different perspectives. To understand this, let
us think about some of the types of socioeconomic arguments. First,
unemployment increases crime. Second, indoctrination by cults will make
individuals more likely to commit criminal acts. Third, men are more
likely than women to commit crimes.
In the rst two cases, a similar argument will be found from a much
simpler method using economic theory. We might remember from the
rst chapter that one of the most important components of the cost of
something is its opportunity cost, that being the value of the opportunity
that one forgoes because one chooses to engage in something else. If some-
one is employed, the choice to commit a crime must include the potential
he will lose his job. However, if someone is unemployed, he does not face
this cost (although he may face the opportunity cost of potentially not being
hired in the future but people tend to discount the future and thus place
more emphasis on the present). We know from the law of demand that as
the cost of something drops, more of it is demanded. Thus, if the cost of
committing larceny were to drop, you would expect more larceny to be
committed. Voila! Unemployment increases crime.
The second case is one where the perceived marginal benet from
engaging in illegal activities sanctied by the cult is increased after exposure
to the cult. We know if the benet from something is increased and the
cost remains the same, more is demanded.
In the third case economics has little to say about gender. Women tend
to earn less and draw lighter sentences for crimes and thus, all other things
were equal, we might conclude women would be more likely to commit
crimes. However, gender is a variable that upsets the all other things being
equal assumption and whether men or women are more likely to commit
criminal acts is usually outside the economic realm.
The problem is socioeconomic, psychological, and physiological theo-
ries of criminality cannot explain why well-to-do individuals in society
commit criminal acts. Why would a Martha Stewart engage in insider trad-
ing? Why would Ray Caruthers commit murder? These individuals do not
t the prole the other theories use but economics can explain it: they did it
because they thought the benets they would receive outweighed the risks asso-
ciated with getting caught.
But dont the other theories matter? Yes, they do. Changing the societal
roles of men and women, so that men do not view the use of force as an
acceptable means of getting what they want, would reduce crime. Increased
use of drugs that could alter chemical imbalances in the brain and better
treatment for mental illness are all positive steps in reducing crime. How-
ever, if we choose to ignore the choice component to crime, we do so at our
own peril. Even those who are mentally ill have chemical imbalances, or
who are conditioned to think violence is a proper response to conict will
be more likely to commit crimes when the perceived benets from such a
course outweigh the perceived costs. For those who do not t the prole
suggested by the other theories, only the economic theory of crime can offer a
hope to arrest their criminal tendencies.
Property Crimes and the Rational Offender

A rational criminal will examine benets and costs of an action to determine
if they should proceed. We can employ a decision model where expected
benets and costs are examined and then see how this will affect behavior.
We begin with someone who is determining whether to become a thief.
With property crimes, criminals receive monetary and psychic benets.
Monetary benets may be known or unknown. A thief deciding to steal a
car might already have a fairly accurate idea of a cars worth. She might
have less knowledge about a paintings value. The would-be thief has an
expected rate of success. Crimes with a low probability of success are less
desirable. She may receive other non-monetary benets. Perhaps stealing a
car or knocking over a convenience store is a thrill. The more the thief
enjoys this work, the more likely she will engage in it.
On the other side of the ledger are costs. There are several categories of
costs for the criminal. First are direct costs associated with the operation.
This includes payments for equipment, store plans, or even bribes. A clerk
might be bribed to look the other way while the thief pockets an item.
There may be payments to someone to drive the getaway car. Second are
indirect or opportunity costs. While casing a store, the thief cannot simul-
taneously be engaged in gainful employment or leisure activity. The third
type of costs are psychic costs. For most people psychic costs are the largest
reason for engaging in lawful behavior. People may be racked with guilt or
feel a compulsion to obey the law. Breaking the law is far less likely for such
individuals. The fourth type of cost is apprehension-risk cost. The greater
the chance of apprehension, as well as the greater the cost to the individual
of being apprehended, the less likely the individual will commit crime. The
nal cost is expected punishment risk. This is a complicated matter incor-
porating both the subjective probability of being punished by the penal
court system (contingent upon apprehension-risk cost) and the subjective
probability of being punished by the person you are attempting to rob (by
being shot). Thus a law allowing concealed weapon permits increases this
risk, as does a law stiffening penalties for burglary. These are subjective
probabilities because they are in the mind of the perpetrator rather than
being the actual probabilities, which are unknown to the would-be
criminal.
Finally, we have to consider whether the thief is risk-averse, risk-
neutral, or risk-seeking. If she is risk-neutral, a simple cost/benet analysis
can calculate whether to engage in the behavior. If the benets outweigh
the costs, she will do it. If she is risk-seeking, she might engage in some
activities for which costs outweigh the benets: she simply likes to take
risks. If she is risk-averse (as most people are), she will be less likely to
engage in activities unless benets greatly outweigh the costs. Risk aversion
changes with age. As people grow older, they become more risk averse.
This is one reason why older people are less likely to engage in criminal
behavior (they also tend to lose more from the activity and are more likely
to correctly evaluate the true level of risk).
Catherine and Michael are deciding whether to steal cars. Each stands
to gain $2000 from a successful theft. The probability of success is 90%.
Michael receives a thrill from this activity. He is willing to pay $200 for
the opportunity to steal a car. If Michael were working for someone else he
could receive $200 less than Catherine and still be willing to steal the car.
However, since he is working for himself, we think of him as paying
himself $200 to steal the car. This benet accrues regardless of success.
Catherine receives no such thrill. She steals strictly for the money.
The benet side of the ledger looks something like this:
Michael: (Probability of success Gain from theft) + Thrill =

(0.90 $2000) + $200 = $1800 + $200 = $2000
Catherine: (Probability of success Gain from theft) =

(0.90 $2000) = $1800
Both use a coat-hanger to open the car door and both know how to
hot wire a car. Therefore, there are no direct costs. Michael faces an
opportunity cost of $300 by taking a day off from his job while Catherine
would have to give up a day at the beach, which she values at $75. Cathe-
rine, unlike Michael, is rather religious and feels guilty about stealing. That
guilt can be negated if she receives at least $400 worth of benet from the
theft. They both think they have a 10% chance of getting caught and, if
they are caught, they believe it will cost them $1000 in court costs and
time. There may be other costs as well (such as the cost of humiliation
from being arrested) but we will ignore these as they only serve to compli-
cate matters unnecessarily. They also believe, if they are caught, they have a
50% chance of being convicted of a crime and being sent to jail for 1 year.
Calculating the expected cost of punishment is more complicated.
Michael will lose $30,000 of income if incarcerated. Catherine faces a loss
of $25,000 in income from a prison term. These are not the only costs
involved. There are psychic costs associated with the loss of freedom. This
will tend to increase the cost of being sent to prison. There are also
reputation costs that reduce future employability. Such rsum damage can
be far greater in the long run than the cost of lost income from the initial
term in prison. Yet, prison is not entirely a bad deal. One receives free
room and board and an admittedly small wage is sometimes paid for prison
labor. Prison offers the opportunity to acquire new skills that aid in the
pursuit of legal income (through vocational classes) and illegal income (by
mixing with known criminals, one might acquire additional skills and con-
nections that can enhance ones criminal career). Ideally, these benets and
costs must be discounted back to present value, a topic covered in Chapter
1. However, we will assume all additional costs and benets cancel out and
the result is the earlier stated losses of $30,000 for Michael and $25,000 for
Catherine represents the actual present-value cost of punishment.
The cost side of the ledger thus looks something like this:
Michael: Opportunity cost + (Probability of getting caught Cost of

getting caught) + (Probability of getting convicted Cost of getting con-
victed) = $300 + (10% $1000) + (10% 50% $30,000) = $300 +
$100 + $1,500 = $1900
Catherine: Opportunity cost + Guilt cost + (Probability of getting

caught Cost of getting caught) + (Probability of getting convicted
Cost of getting convicted) = $75 + $400 + (10% $1000) + (10%
50% $25,000) = $75 + $400 + $100 + $1,250 = $1,825
Both are risk-neutral, so if costs outweigh the benets, they will engage
in the behavior. Thus Michael sees a benet of $2000 and costs of $1,900.
He steals the car. Catherine sees benets of $1,800 and costs of $1,825.
She decides not to steal the car.
What happens if we impose an additional $16,000 ne on those who
are convicted of stealing cars? This will have the impact of raising the cost
of stealing a car by 10% 50% $16,000 = $800. All of a sudden
Michael isnt stealing cars anymore.
What if instead of a ne, we increase the likelihood of apprehending an
individual from 10% to 15%? This is an additional 5% $1,000 + (5%
50% $30,000) = $50 + $750 = $800 penalty on Michael. Raising the
likelihood of apprehension from 10% to 15% has the same effect on
Michaels behavior as imposing a $16,000 ne.
Similarly, suppose we do nothing but now Catherine no longer feels

guilty about stealing? Now her costs drop to $1,425 and she decides to
steal a car.
The interplay of costs and benets dictate what someone will do. Our
theory helps us on multiple fronts. It provides justication for adjusting
penalties, such as increasing nes, but it can also be used to argue in favor
of programs that use moral suasion to persuade people theft is wrong. By
making individuals feel guilty, we can reduce crime. An example of this is
the piracy is stealing commercial produced by the Motion Picture Asso-
ciation of America.
Increasing the likelihood of apprehension and conviction usually has a
greater deterrent value than increasing penalties that are unlikely to be
enforced. The greater the probability a penalty will be applied, the lower
the penalty needs to be. We could increase the direct costs of crime by
taxing the tools of the trade or we could increase the opportunity cost of
crime by increasing salaries and putting the unemployed to work. Indivi-
duals can raise the cost or lower the benet of stealing their cars by instal-
ling alarm systems or automatic tracking devices. We can decrease the
benet from crime by cracking down on those who trafc in stolen car
parts and by making it more difcult to hot wire a car. Each of these tech-
niques will reduce car theft.
Producing Crime?
You will notice the decision to commit a crime is based on an evaluation of
relative benets and costs. In this section we will examine the question of
how much crime to commit, using the tools that we rst described in
Chapter 1 and adding some new ones.
Criminal activity is often an extramarket activity operating outside the
market mechanism. There is no transaction that we can see between two
individuals in many cases. Instead it is often a choice between two equally
unsavory options. Comedian Jack Benny popularized the notion of a trade-
off with his classic routine that made fun of his persona as a miser. In it, he is
accosted by a robber who demands either your money or your life. A preg-
nant pause ensues when the robber again demands your money or your life,
by which time Benny delivers the classic refrain, Im thinking about it.
Crime is a production decision. Criminals either are consumers beneting

from such activity or producers who provide it. In some cases, this is one and
the same person but, to understand this process, consider the question of
murder for hire. The person who benets from the criminal activity is the
one hiring the hitman to commit the act. The person who commits the act is
creating a service (albeit an illegal and immoral one) and the person paying
for the service is the one who benets its creation. Similarly, a fence buying
stolen goods enters into a transaction with a thief selling those goods.
A production decision is made based upon maximizing benets
(whether nancial or otherwise) or minimizing costs to the producer of some
kind. In the case of a legitimate business, those benets are monetized as
revenues. Businesses produce goods by combining various factors of produc-
tion together in a production process. Factors of production are land, labor,
raw materials, or capital equipment used by a business to produce a good or
service. A producer of heroin needs a place to work (land), workers (labor),
opium and lime to create morphine (raw materials), various industrial che-
micals used in the conversion process from morphine to heroin (more raw
materials), and something to cook the various mixtures (capital equipment).
No, I am not going to tell you what chemicals to use. You didnt think I was
actually going to teach you how to create heroin in this book, did you?
The process of going from cultivated opium to heroin is a production
process. To understand production decisions, economists differentiate
between the short-run, during which the quantity of at least one factor of
production does not change, and the long-run, during which all factors of
production may vary.
As discussed in Chapter 1, the supply curve slopes upwards: as the price
rises, more is produced. One reason is declining marginal product. Suppose
you run a small heroin-production facility and, one day, you see an increase
in demand. You can offer your product for more money because of this and
you have an incentive to do things you otherwise would not do to satisfy
that demand. You might remain open later or pay extra for delivery of
opium and industrial chemicals to your facility, while on an ordinary day
you would pack up and go home when your supply is exhausted. If you are
employing others, you might pay them overtime to meet the demand from
the customers or you might hire temporary workers to assist them. What
you will be unable to do, in all likelihood, is physically expand your facility.
That means you might fall behind in lling orders and lose some sales to
other facilities. If, on the other hand, you noticed an increase in demand
that would continue indenitely, perhaps owing to the unforeseen death of
one of your competitors, you might invest in more expansive facilities.
However, it is unlikely you would do so for a temporary spike in activity.
Normally, if you expand your facilities by increasing all factors of pro-
duction at the same rate, your costs will roughly double as your productive
capacity doubles and per unit costs will remain the same. When all factors
of production increase and production increases at the same rate, it is con-
stant returns to scale. However, if you only hire additional workers or have
opium brought in by special delivery, per unit costs will rise as production
rises. Since per unit costs rise with production when you fail to expand
your facility, economists say you are experiencing declining marginal prod-
uct in terms of labor or capital. In order to produce more, you must be
compensated more for each additional ounce of heroin. Your supply curve
will slope upward.
On the other hand, suppose you expand all of your inputs and your
costs increase at a lower rate than the expansion in your productive capacity
since you were able to negotiate a quantity discount on raw materials or
capital equipment. In such a case we would say you experience increasing
returns to scale because production increases at a faster rate than the increase
in the factors of production. Per unit costs fall.
A third possibility is decreasing returns to scale when production
increases at a slower rate than the increase in the factors of production.
This might occur in criminal activity because more activity means a greater
probability of detection by the authorities. It might not even be worth it to
expand production at all.
Black and Gray Markets

A black market exists when a product is outlawed or its purchase or transfer
of ownership is restricted. Thus, you can have a black market for a product
that is legal, such as controlled substances, available normally only with a
prescription. Gray markets occur when a product is transferred from one
legal market to another without the consent of the owner of the product.
To understand the difference, we are going to look at four different
markets running along the continuum of illegal to legal markets. The rst
is the market for heroin, the second is the market for rental housing under
rent control, the third is the market for video game consoles, and the fourth
is the market for textbooks.
The sale and distribution of heroin is a classic example of an illegal
black market. According to the CIA, there are roughly 2 million heroin
users in the United States, with approximately 35% being hardcore
addicts. According to the United Nations Ofce of Drug Control, the
global heroin market totals $55 billion and all of it is in the form of cash
payments (to my knowledge, heroin dealers not only do not accept Amer-
ican Express but they also dont take Visa, MasterCard, or Discover) or in-
kind services, which usually consist of sex for drugs. Heroin is big business,
taking in more money than Hollywood does at the box ofce and with
DVD/Blu-ray sales combined.
Making something illegal does little to eliminate its use. Sales of alcohol
did not cease during Prohibition; they simply went underground. If the
government wishes to control sales of illegal drugs, they must go after
either the suppliers or the consumers of the substances. By interdicting
such sales, the government attempts to stem the trade. From the stand-
point of economic theory, the only way to prevent people from consuming
or selling drugs is to cause expected costs to exceed the expected benets
from the activity. Incarcerating drug users (Figure 2.1) will cause a decrease
S
Price
D0
D1
Quantity
Figure 2.1. Incarcerating drug users.

in demand for the product. Similar reductions may occur as the result of
increased education about the effects of drug use or be increased spending
on addiction-recovery programs. On the other hand, if we incarcerate drug
dealers (Figure 2.2), it will cause a decrease in supply.
When we incarcerate drug users or otherwise limit demand, we
increase the opportunity cost of obtaining heroin but we also make it less
protable. The decline in price resulting from the reduction in demand is
cancelled by the increase in cost resulting from the possibility of jail time.
The reduction in prot lowers the number of producers in the market and
the decrease in prot reduces incentives for organized crime to enter.
When we incarcerate drug dealers, equilibrium price rises. While this is
due to increased costs associated with the possibility of incarceration, it
also leads to rent-seeking by criminals. By paying bribes to the police, they
can effectively eliminate this penalty and thus receive supranormal prots
while those not under such police protection will be going to jail. In
corrupt regimes, there is never a lack of enforcement actions but the mixing
of criminal elements and law enforcement effectively ensures the trade not
only is not eradicated but organized crime will enter or persist in the mar-
ket. We will return to the drug market in Chapter 4 on organized crime
and Chapter 5 on victimless crime.
When a jurisdiction legislates rent control, housing becomes a black
market where the product itself is legal but the mechanism for transmission
S1
S0
Price
Quantity
Figure 2.2. Incarcerating drug dealers.

is restricted. There now exists an inefcient legal market side by side with a
black market. This inefciency is represented by the area called deadweight
loss. It is that which is lost to society that goes to no other individual.
Suppose a hurricane hits your area and the cost of getting water goes up.
Not to worry, I am from the government and I am here to help you! I
forbid selling water for more than the price that it was before the hurricane.
Great idea, right? Wrong! The problem is it might cost more to bring in
water from outside than merchants can receive in payment. Now no mer-
chant wants to sell water and everyone wants water. If the government
stayed out of the market, the people who really wanted the water would
be willing to pay more money for it and the market would nd an equi-
librium where everyone willing to buy at the market price and sell at the
market price could engage in trade. But that doesnt happen now! Instead,
we have a lot more people demanding water and a lot fewer selling it.
Returning to rent control, the imbalance caused by this law, along with
resulting deadweight loss is illustrated in Figure 2.3.
P is the price and Q is the quantity prevailing in the absence of rent
control. P* is the price set as the rent ceiling, the amount over which no rent
can be charged. Q1 represents the number of units offered and rented under
rent control. The number of rented units will be fewer than would prevail
under a free market but it would appear the price that each person would
pay would be lower. However, while the former statement is true, the latter
P1
Rent ceiling
P*
Q1 Q Q2
Figure 2.3. Rent control.

is not. At the price, P*, there are a number of people who will wish to rent
but who will be unable to at the market price. Demand for units will be Q2
and the number of people shut out of the market would be Q2 Q1. Many
of these individuals would be willing to pay above the rent control price. If
we restrict supply, the actual rent paid will be P1 and not P*. You might
wonder how this can be when there is a legal rent ceiling but there are many
ways people will pay for something without paying money for it.
First, since there are fewer units available, search costs will increase. Con-
sider what happens when you hear about a sale going on across town. Sup-
pose you nd you can save $0.50 on lemonade if you drive ve miles to get it
instead of going to the stand across the street from your house. Are you going
to do it? How about if you save $200 on a computer? Alternatively, suppose
you are standing before two lemonade stands. One is selling lemonade for
$1.00 and the other for $0.50. There is no other difference between the two
stands and there are no lines. Isnt it clear while you will go for the less expen-
sive alternative in this latter case, you are unlikely to drive ve miles across
town for the benet (assuming that would be the sole reason for going to the
location that is further away). Yet we are willing (in most cases) to make such
a trek to save signicantly more money. Now think about housing. With
fewer units available, it isnt simply a matter of traveling a greater distance; it
might be that with fewer units available, it is going to take longer to nd your
desired apartment. Even if this isnt the case for you, some people will take
longer to be able to nd an apartment or else will be taking apartments they
nd less desirable than they would in a free and fair market.
Second, apartments might come with restrictions. Perhaps landlords
will not allow pets. Maybe they cut back on incentives. No longer will a
refrigerator be offeredthe tenants will be expected to provide it them-
selves. Utilities might have been included before and now are not. These
factors will drive up the actual price of housing.
Landlords might do less upkeep on their units or might discriminate
against certain types of individuals. They might prefer a white-collar pro-
fessional instead of a college student because they worry about parties or
excessive cleanup after the student leaves. They might ask for higher clean-
ing deposits and retain a greater proportion of such deposits. Unscrupulous
landlords might even demand bribes before renting. Such illegal agree-
ments are made in the context of a black market.
Leaving aside the question of rent control, we now turn to goods that
are legal when sold in one jurisdiction or to one group of individuals but
not another. The market for video games is a classic example of such a
market. Certain game consoles, such as the Xbox and PlayStation 2, were
deemed subject to export controls and could not be sold to certain coun-
tries because the computer chips could be harvested from them for use in
military equipment such as missile guidance systems. Various games, such
as Grand Theft Auto, cannot be sold to minors in certain jurisdictions. The
effect of such restrictions is to create a black market but of a different sort.
Since some individuals can still purchase the goods, there is only a small
suppression of demand. Instead, people will purchase the goods in the legal
markets and then sell them in the illegal markets at a markup to account
for the potential cost of getting caught.
We begin by assuming the two markets operate in a world without
transportation costs, price restrictions, or export constraints. Before one of
the markets is declared to be an illegal one, prices in both markets are
identical at the worldwide price (Figure 2.4).
When the product trades freely and without restrictions on transferring
products between the two markets either legally or economically, the price
is the same in both markets (if it were higher in one market than another,
goods would move from the market with the lower price to the market
with the higher price, causing a rise in price in the former market and a
lowering of price in the latter until the two markets once again had the
same prevailing price). However, circumstances change after the product
is declared illegal in one market (Figure 2.5): it will still trade at the world-
wide price in the legal market but it now trades for the worldwide price plus
a smuggling premium in the second market. We have also reduced demand
S
S
Worldwide price
D D
Figure 2.4. Before a market is declared illegal.

S
S
Worldwide price
Smuggling
premium
D D2 D1
Legal market Illegal market
Figure 2.5. After one market is declared illegal.
in the illegal market from D1 to D2, to account for the reduction in

demand from moral suasion produced by declaring the good illegal and to
account for the increased search costs associated with trying to nd black
market goods. You will notice the supply curve begins above the worldwide
price whereas below it did not. This is because the supply of goods is com-
ing not from the manufacturer of the product but from the illegal supplier
of the good in question. Since they must purchase the goods at the world-
wide price, they need to markup the price over their initial cost in order to
make a prot. This assumes the goods that are sold are genuine goods
bought legally. Of course, with the potential for smuggling prots also
comes the incentive to trade in stolen or counterfeit goods, which will
likely be sold at a discount because of lower acquisition costs.
Turning now to the gray market for textbooks (the same analysis we
will now undertake can be used for counterfeit or stolen goods as well).
Textbooks in the United States and Canada are typically hardcover and
there is a big market for used textbooks. The rationale for the secondary
market is the high cost of new textbooks. Foreign markets frequently mar-
ket the so-called international editions that cost considerably less and are
often paperback. Used-textbook markets are rare in such locales. Interna-
tional editions are sold without return rights while new hardcover text-
books are sold with bookstores having the right to return excess copies
to the publisher. Publishers engage in market segmentation in an effort to
raise revenues. This type of behavior is characteristic of price discrimination,
which is when a company prices products differently due to volume, group
membership, or some other criterion. Further discussion of price discrim-
ination will be found in Chapter 4.
The key to successful price discrimination is to ensure an individual

who pays a low price cannot successfully sell it to someone who ordinarily
pays a high price. Thus admission to a theme park for a child may be priced
lower than that for an adult because the adult cannot go up to the gate and
claim she is 8 years old and get away with it. At the same time, the con-
cessions within the park are priced the same for adults and children since it
would be trivially easy for the child to simply order food for the adult.
Book publishers try to prevent arbitrage by mandating bookstores in
the United States and Canada refrain from selling international editions.
Bookstores that violate these clauses may nd they are no longer able to sell
domestic editions of textbooks. Customs may refuse entry of such editions
because international editions carry with them the restriction they are not
to be exported to the United States or Canada. In so doing, international
editions are sold for a lower price than the corresponding U.S. editions. In
addition, international editions are often sold on lower-quality paper. Still,
even the U.S. editions of textbooks can often be purchased at lower cost
abroad than at home. Yet, in these cases, textbooks are sold directly to
university bookstores with the proviso they are not subsequently exported
without the permission of the textbook publisher. Violation of these terms
can lead to a refusal to sell editions to the violating bookstores.
Prices of international and domestic editions differ due for two reasons:
(a) relative quality differences and (b) non-tradability clause enforcement.
We now look at how this market will react if a criminal element decides to
trafc in international textbooks. Figure 2.6 illustrates how the market
looks prior to the attempt to arbitrage (Figure 2.6).
Price difference
due to quality
Price
differences
Price difference
due to market
segmentation
International Quantity US/Canadian Quantity

market market
Figure 2.6. The gray market of textbooks.

As arbitrage occurs (Figure 2.7), price and quantity sold in the inter-
national market will rise, due to an increase in demand as the arbitragers
buy more and more goods. The price and quantity sold in the U.S./Cana-
dian market falls due to lower demand for new domestic editions. Stu-
dents who formerly bought domestic editions now buy international
editions. It is important to note the price in the international market may
not rise by as much as the price in the U.S./Canadian market falls (or,
conversely, it may rise more than the price in the U.S./Canadian market
falls). The degree to which price changes depends on the slope of the
supply curves in both markets with atter supply curves resulting in lower
price changes than steeper supply curves.
With the gray market, the impact on the rms eventual prots is the
reduction in prot due to market segmentation elimination. Higher
income in the international market only partially compensates for lower
revenue from the U.S./Canadian market. A prot-maximizing rm that
can earn more money by selling the same product at the same price will
do so and thus not engage in price discrimination. One difference between
gray markets and black markets that coexist with legal markets is that price
converge only occurs with gray markets. Black markets do not see prices
converge because the selling activity itself is illegal and thus commands a
pricing premium.
The effect on domestic sales of pirated or counterfeited products is a
reduction in total sales and lower prices. In this case, products are not trans-
ferred from one market to another. After all, pirated or counterfeited goods
S
S
Price falls
Price
Price difference due

to quality difference
Price
rises
D0
D1
D0 D1
Quantity Quantity
Quantity transferred Quantity transferred from
to US/Canadian market international market
International market US/Canadian market
Figure 2.7. Arbitrage opportunities in the gray market of textbooks.

are produced by the pirate or counterfeiter. Total goods production may,

and indeed probably will, exceed that which is sustainable in a purely legal
market, whereas, by the very nature of arbitrage, this is not the case for the
gray market. Lost prots for intellectual property owners in the case of
pirated and counterfeit goods are less than reductions in revenue since
fewer legal products are being produced. What is lost on each unit sold is
the margin between the cost of production and the price paid by the con-
sumer and not the total revenue. Added to this must be the loss in revenue
from each sold unit caused by the reduction in sales price. On the other
hand, stolen goods carry with it the loss associated with the cost of pro-
duction. Stolen goods are produced by the company experiencing the
theft, so stolen goods result in higher prices for the legally acquired goods
even as they lower prices for the stolen property.
Rational Murder
Murder appears to be irrational: how can killing someone be reduced
to a pleasure/pain calculus? However, let us look at why people mur-
der. One motive is nancial. If one looks at murder for prot, the
economic approach ought to make sense and, if we increase the likeli-
hood or severity of penalty, there ought to be fewer murders. At the
same time, if the likelihood or severity of penalty falls, we should see
more murders.
Evidence supports this. Murder clearance rates (the rate at which mur-
ders are solved) have actually fallen quite dramatically over time. In the
early 1960s, the murder clearance rate in the United States and Canada
was near 90%. By the early 1990s, the U.S. rate had fallen to the mid-
60%, where it has remained since. The murder clearance rate for Canada
has seen a similar trend but it has not fallen as precipitouslythe clearance
rate for murder tends to be about 10% higher than in the United States. A
falling murder clearance rate, all other things being equal, should increase
the number of murders. In the early 1950s and the 1960s, the murder rate
was quite low, even lower than today in both countries. By the late 1980s
and the early 1990s it had risen dramatically while clearance rates had
fallen. However, when clearance rates stabilized, the murder rate started
to fall. Thus the murder-rate rise and the clearance-rate drop appear to be
related: when people nd they are less likely to be caught, they tend to do
more illegal activities.
At the same time, we can look at the effect of capital punishment.
Higher murder rates were rising before the death penalty was eliminated
in the United States in 1972 and also rose for several years after it was
reintroduced in 1976. Yet between 1972 and 1976, murder rates did not
show a trend. Neither did clearance rates during that time period. Clear-
ance rates appear to have a more profound impact than the ultimate
punishment.
Does that mean capital punishment is not a deterrent? The evidence is
mixed. Capital punishment is by no means a certain event. Despite over
700,000 murders since the death penalty was reintroduced in the United
States in 1976, less than 1,400 people have been executed since then. As of
August 2013, there are 32 states covering two-thirds of the population of
the United States that have the death penalty. Only about 3,200 indivi-
duals are on death row. Even Texas, the capital punishment capital of the
United States, has seen only 500 executions but over 60,000 murders since
1976 and currently it has only about 300 people on its death row. Not all
will face execution. Even if one makes it to death row, it can take several
years for the sentence to be carried out and, in many states, a death row
inmate is more likely to die of natural causes than to be executed. A death
sentence is not going to be much of a deterrent if it is to be carried out
several years in the future and if it is an extremely unlikely event from the
standpoint of probability.
At the same time, we have a signicant number of individuals who do
believe that it has deterrence value. If, among those numbers, there are
people who might commit murder, then the death penalty will have a
deterrence value for those people.
The economic theory of crime suggests the death penalty is seen as a
more severe penalty than life imprisonment. But it has to be used to be
effective. The actions of those on death row attempting to stave off execu-
tion give testament to the fact that, for many people, this is true. Inmates,
such as Gary Gilmore, the rst individual executed in the United States
after the death penalty was reintroduced, who accept or even seek the death
penalty are few and far between. At the same time, evidence that the death
penalty acts as a deterrent is mixed. Even though it deters some people,
once a murder is committed, what stops people from killing again? Cer-
tainly moral considerations may come into play but the threat of punish-
ment no longer hangs in the balance unless either the likelihood of capture
or sentence is increased as a result. The constant media circus and the
transformation of killers such as Jessie James into folk heroes can result in
signicant utility being gained from such killings by those who crave atten-
tion. Since this media frenzy is typically greater for those convicted of the
death penalty, it might offset or even overturn the deterrence effect in some
individuals. We will further discuss murder as a rational act in Chapter 7.
Rational Addiction
In discussing supply and demand, I made the comment that there is some
dispute as to whether preferences are stable or subject to change. Many
economists argue preferences are stable but this is not a requirement for
the use of economic theory. In this section, we contrast the economic
approach and the constructive processing approach.
Traditionally, the economic approach assumes people have stable pre-
ferences. This creates a need to explain advertising. In two classic articles,
Nelson1 argued advertising was information and, therefore, as consumers
watch advertising, they become better informed about products and, thus,
are better able to make appropriate purchasing decisions. Consumer tastes
do not change; information about products increases. In acquiring more
information, buying patterns change. What we see as a change in prefer-
ences is simply the problem of measuring the wrong variable. Goods that
are advertised are, for the most part, legal goods: the exception being the
advertising of goods that are legal in the jurisdiction where the advertising
is placed but illegal in the jurisdiction where the advertising is read. As
such, advertising from the standpoint of crime is typically informational
in context: public service announcements detailing how one can report
crimes or nd missing children t this description.
This information may be helpful or harmful; it might contain lies and
appeal to us through suggestion. There is good reason why cigarette com-
pany advertisements once contained images of healthy young individuals
smoking: companies were attempting to counter health warnings on their
packages. Similarly, beer commercials use sex; car commercials use rugged
individualism; and soft drink commercials use popular culture (you are
with it if you drink their product).
These issues are addressed in a separate argument, which is de gustibus
non est disputandumthere is no use arguing about matters of tastes.
Most economists dont argue tastes are immutable; they simply argue we
can treat tastes as if they were immutable. Some economists even go so far
as to claim that tastes not only do not change within individuals but are
actually the same across individuals. Stigler and Becker2 in their classic arti-
cle that uses as its title the aforementioned Latin phrase, argue it is differ-
ences in human capital (including education and work experience) that
account for differences in behavior. In other words, the reason why people
differ in tastes of music, art, or literature isnt because of different prefer-
ences but instead because their human capital (for example, a college edu-
cation) provides complementarities that lead them to partake of such
things. Most economists reject this extreme position but still want to main-
tain the notion preferences are stable within individuals. The fear is if pre-
ferences are alterable, the rational actor model will be unable to explain any
behavior.
With stable preferences, however, one must be able to explain addic-
tion. Becker and Murphy3 argue people might rationally choose to
become addicted to drugs or alcohol. Addiction is characterized by both
reinforcement (consumption in the present raises consumption in the
future) and tolerance (the level of consumption necessary to obtain the
same level of satisfaction increases over time). In the case of harmful addic-
tions, there is an increasing toll taken on the individual. This tends to
increase the price of the good over time. Also, as an individual gets older,
her time horizon shortens. Individuals do not live innite lives and thus
the potential future damage from the good declines over time. As we
learned in the last chapter, individuals discount future costs and benets
to the present. In such cases, the price of the good may rise over time if the
damages increase at a rate faster than anticipated by the individual when
they took up the addiction or it may fall if damages fail to increase at the
anticipated rate.
The rational addiction model makes predictions conrmed by research.
It is more likely smokers suffering a heart attack will quit because they are
now aware of the greater cost associated with their addiction than if they
were to simply wake up one day and decide not to smoke. Similarly,
changes in family situations such as the birth of a child will raise costs of
such damaging behavior and precipitate a change.
Those who live more in the moment are more likely to become
addicts since their short-term pleasure exceeds the benets from long-term
abstinence. Stress increases the likelihood of addiction because many of
these harmful addictions can alleviate short-term stress. Stress also tends
to alter shorten time preferences, making addicts see the world through
a short-term lens. Greater income brings with it both greater availability
to purchase harmful goods but also increases the cost of taking them
because many such goods are debilitating or are illegal. Thus, the impact
of income is indeterminate.
In recent years, Becker4 has moved to a position that semantically
stays within the preferences are immutable framework but is, for all
practical purposes, an acknowledgment they are not. He does this by
dening an underlying utility function he says is immutable, consistent,
and identical across all individuals and all times. He then argues each
individual at varying times has a subutility function that causes her
behavior to differ because of differences in personal experiences and past
consumption (referred to as personal capital) and in peer pressure and
culture (referred to as social capital). As such, consumption patterns
and decisions by peers and the individuals themselves cause the utility
derived from engaging in a particular action to differ. It is a return to the
imperfect information argument. The reason why people differ in
behavior is because experiences are different and these differences in
experiences alter prices individuals pay for goods. This implies the price
you pay is not the list priceit is the list price coupled with the oppor-
tunity cost you pay to consume the good. It is the opportunity cost and
not the list price that is altered by past experiences. This allows Becker to
conclude only prices and income, and not tastes, are affected by addic-
tion and advertising. He uses a similar approach to discuss fashions, fads,
and habits.
However, the rational actor model does not need stability of prefer-
ences to be worthwhile. It merely postulates preferences tend to be stable
when aggregated over individuals over a short period of time or, to the
extent preferences do change, there is an ability to scientically predict
these changes. This is the approach of the constructive processing

approach that argues preferences change over time based on past experi-
ences and the information available at the time. One implication is that
people may adopt a herd mentality when others are engaged in similar
behavior. Similarly, they may consistently overestimate their ability to
undertake a task. The vast majority of drivers, for example, believe them-
selves to be above average in ability, something that clearly cannot be
true. Similarly, criminals may consistently underestimate the likelihood
they will be caught, especially if they have gotten away with crime in the
past. For further explanation as to how people can consistently misrep-
resent their subjective probabilities, see the section on the Winners
Curse later in this chapter.
The difference between these two approaches may mean little differ-
ence when it comes to determining individual behavior but it has impor-
tant distinctions when it comes to public policy. If preferences are
immutable, we should expect to see older people engaged in more risk-
taking behavior, such as crime, and plan accordingly. After all, it would
appears as though costs associated with engaging in such behavior are far
less for the elderly than the young. They have fewer years to live. Their
wage-productive lives may have already ended. It is also unclear what ill
effect taking up smoking would have on the health of a 100-year old. How-
ever, we actually nd that the opposite is the case: risk-taking is a behavior
that aficts the young, not the old.
The reason for this is actually not because costs fall over time. Instead,
as one grows older, ones estimate of future earning power and lifetime
expectancy asymptotically approaches its true value. As such, it is uncer-
tainty about future income and survivability that drives addictive behavior.
This, of course, requires people to systematically err in favor of a belief they
will live longer than they really will or make more money than they will in
order to acquire an addiction that they will later regret. This is, of course,
characteristic of risk-taking behavior found among both addicts and
criminals.
If preferences are the mere reaction to changing circumstances, envi-
ronment and not biology would be destiny, a premise that is contradicted
by existing research. Both biology and environment appears to control
human behavior.
The Winners Curse

Doesnt the assumption criminals behave rationally preclude them from
making systemic errors in subjective probabilities? Absolutely not. To
understand the reason why criminals consistently overestimate their prob-
ability of successful elusion of the authorities, we are drawn to an example
in the economics literature called the Winners Curse. We can demon-
strate it with a simple experiment that you can conduct with your friends at
a party. Take a large glass jar and ll it with pennies. Then place the jar in
the center of the table. Allow your friends to bid for the contents of the jar.
The person who bids the most wins all the pennies in the jar but must pay
you her winning bid. To control for penny aversion, it is best to count out
how many pennies are actually in the jar and agree to award the value of the
sum total of pennies in the form of dollar bills and coins so as to minimize
the number of coins to be given out. For example, if the jar contains
527 pennies, you would give the winner a $5 bill, a quarter and two pen-
nies instead of forcing her to handle all 527 pennies. She, of course, must
hand over to you her bid. What do you think will happen? Experiments
suggest if you have a large enough group (20 or 30 should do the trick), the
average bid will be less than the value of the pennies in the jar but the
winning bid will exceed the value of the pennies in the jar.
The reason the average bid is lower than the actual number of pennies
is most people display risk aversion, meaning when faced with a risk, they
mitigate it. Since you can only make money if you bid less than the value of
the contents of the jar and you will lose money if you have the winning bid
but exceed the value, people tend to underbid. This is the same reason why
people purchase insurance: they fear potential loss and want to protect
themselves. Insurance companies are risk neutral because they aggregate
numerous risks and develop a portfolio that self-insures against risk. They
are willing to take risks individuals are not and thus they receive a risk
premium for insuring people.
The reason winning bids typically exceeds the value of the pennies in
the jar has less to do with risk aversion than the natural distribution of
error. If the value of the coins in the jar is $5.27 and the average bid is
$4.30, some people will bid higher and some will bid lower. The winning
bid is always the highest one, so it often exceeds the value of the coins in
the jar. Indeed, as the number of people in an auction increases, so will

increase the probability the winners curse will be manifested and the win-
ner ends up paying more than the value in the jar. Hence, the curse: the
winner ends up being the only loser.
For the criminal who overestimates the probability he will get away
with the crime, his curse is to be incarcerated for committing this socially
deviant act.
For the Economist: Applying Calculus

The rational criminal looks at the marginal benet from committing crime
and compares it to the marginal cost.5 If marginal benet exceeds marginal
cost, crime is committed; if it falls short, it is not. Since we have presented a
discrete choice model, wherein someone either decides to commit a crime
or not, we can do so without using advanced mathematics. However,
choice isnt always discretely made. Often the question isnt whether to
commit crime (discrete choice) but rather how much crime to commit. To
handle this question, we use calculus. Those who have studied intermedi-
ate microeconomic theory using calculus might nd this exposition useful.
Let us begin with the benets. As benets increase, there is a greater
likelihood of committing crime, all other things being equal. We begin by
assuming the payoff from criminal activity is a function of how many crimes
are committed: the payoff increases with the number of crimes. Let the var-
iable y indicate the number of offenses committed. Revenue generated from
crime is based on the number of offenses committed, r = r(y). We then look
at the probability of being apprehended for the crime, which is based on the
number of offenses committed, a = a(y). Then there is the probability of
being convicted of the crime, c = c(y) and the expected punishment, which
will again be a function of the number of offenses committed, p = p(y). The
expected punishment is the product of the punishment times the probability
of conviction times the probability of apprehension.
The rational criminal will attempt to maximize her own payoff, which
would mean maximizing the difference between the expected payoff and
the expected cost:
max r(y) a(y)c(y)p(y) [2.1]

Differentiating we get:
y = acp + apc + acp [2.2]
The expected payoff is set equal to the change in the probability of

apprehension times the probability of being punished times the expected
punishment plus the change in the probability of punishment times the
probability of being apprehended times the expected punishment plus the
change in the expected punishment times the expected apprehension prob-
ability times the expected punishment probability.
In most cases, these three variables will all be positive, since as the
amount of crime increases so will probability of capture and conviction,
as well as expected punishment. Herein lies the rub: if we impose manda-
tory sentencing that effectively cannot be increased and the individual has
already committed a crime that attracts that mandatory sentence, the nal
term will drop out. This lowers the cost after one commits a crime that
attracts a mandatory sentence! This helps explain why third strikes offen-
ders run when they are cornered. If they are going back to jail for life for
stealing a candy bar, they will try to lower the probability of apprehension
by leaving the scene of the crime.
If the probability of receiving punishment after apprehension becomes
certain, as it is in many countries that lack the rule of law, the best thing to
do is avoid capture in the rst place. Thus, in a society where guilt is pre-
determined when one comes to trial, the sole option is to run: we would
expect very few criminals turning themselves in.
Our system of jurisprudence, by assuming that people are innocent
until proven guilty and providing all sorts of legal impediments to convict,
may actually reduce crime when it is committed by those who are commit-
ting multiple criminal acts because the marginal cost of committing those
acts is always rising (since the more acts that one commits, the less likely
procedural error will cause the conviction to be overturned).
We can also develop the Becker model in a more formal and rigorous
fashion as one of choice under conditions of uncertainty. Becker uses
something called subjective expected utility to determine how potential
criminals approach their task. Subjective expected utility employs a prob-
ability determined by the individual that may be representative of the true
probability. One important distinctions about criminal activity is criminals

generally have an unrealistically low expectation of escaping capture (as
noted earlier in the section on the winners curse).
What divides criminals from non-criminals isnt different motivations
but rather different perceptions as to relative benets and costs of crime as
well as the likelihood of being captured and punished. Criminals might
also be more risk-seeking than non-criminals. Although Becker doesnt
include a specication for considering that some criminals may simply
enjoy committing crime or they might enjoy the risk associated with the
activity, such explanations can also be used to partially explain differences
between these two groups of individuals.
Under von Neumann-Morgenstern conditions for behavior of uncer-
tainty, one compares expected utility gained from committing crime with
that which would be received if one were employed in the formal economy.
Criminal activity is a risky undertaking and employment in the formal
economy is devoid of the risk of punishment.
We formalize this using a standard expected utility model: EU repre-
sents the expected utility for the individual, p denotes a subjective proba-
bility of being ultimately punished for committing a crime, W is the initial
level of wealth, L is the monetary equivalent loss the individual will face if
apprehended, G is the monetary equivalent gain from committing the
crime, and U( ) is the individuals von Neumann-Morgenstern utility func-
tion. The von Neumann-Morgenstern utility function represents the
extent to which a person is willing to accept a gamble over a risk-free choice
of equivalent expected value:
EU = pU (W L) + (1 p)U (W + G ) [2.3]
Beckers original model did not include a parameter for wealth but
our model has such a parameter. This is important because the level of
wealth a person has might inuence her decision to commit criminal
activities. The individual will commit the crime if her expected utility
from the gamble exceeds the risk-free equivalent. Thus, if EU > EU
(W), the person will engage in criminal activity. The decision to commit
crime will depend on the level of her risk aversion, U(*). If someone is
risk-averse, her von Neumann-Morgenstern utility function will look

something like this:
D
U(W+G)
B
U(W)
C
A
U(WL)
WL W W* W+G
Figure 2.8. The risk-averse criminal.
Utility is plotted on the vertical axis and wealth on the horizontal.

The utility given by the line segment connecting point A and point D
represents that level that would be gained if the risk is undertaken. If the
subjective probability of punishment, p, is 1 (certain punishment), the
gamble results in a new wealth level, W L. On the other hand, if p is
0 (no punishment), the gamble results in a new wealth level, W + G. The
closer the probability of punishment is to 0, the greater the likelihood
that the individual will engage in crime. Indeed, even for this risk-averse
individual, provided that the expected wealth of committing the crime
exceeds the level of W*, the crime will be undertaken. The difference
between W* and W represents the risk premium the risk-averse individ-
ual must receive to be willing to accept the gamble of committing the
crime.
Using calculus we can determine what will happen as changes occur
in the severity of punishment, L, the likelihood of punishment, p (which
is always a value between 0 and 1), and the level of wealth of an
individual:
EU
= pU (W L) < 0 [2.4]
L
EU
= U (W L) U (W + G ) < 0 [2.5]
p
These values will be negative so long as the marginal utility from wealth
is positive, the overall level of wealth is positive, the loss incurred is nega-
tive, and the gain from the crime is positive. All of these are standard
assumptions. Of course, if the person believes punishment is actually a
benet, increases in punishment level may actually promote criminal activ-
ity. Such individuals are thankfully rare. Since expected utility declines
under normal conditions with increases in likelihood of punishment or its
severity, the likelihood of criminal activity will similarly decline.
With regard to the gain from crime, as it increases under these same
assumptions, the level of crime will increase:
EU
= pU (W L) < 0 [2.6]
L
The effect of a change in wealth, however, is ambiguous:
EU
= pU (W L) (1 p)U (W + G ) [2.7]
W
If pU (W L) > (1 p)U (W + G ) , crime rises as wealth rises. If the

reverse is true, crime falls as wealth rises. This assumes no correlation
between wealth and loss, i.e., the penalty is purely a nancial one. In prac-
tical terms, the inclusion of prison as a possible punishment will decrease
the likelihood a wealthy individual will engage in the same criminal activity
as compared to a poorer individual. This is because the money value of
time is greater for a wealthy individual, given her greater earning potential.
Since we assume marginal utility from wealth is positive and p is
between 0 and 1, we can rewrite this inequality as:
1 p U (W L)
< [2.8]
p U (W + G )
However, if
1 p U (W L)
> [2.9]
p U (W + G )
the opposite is true. An increase in wealth will reduce crime.

If the marginal utility of wealth falls as income rises, then
U (W L) 1 p
< 1 . Therefore, if > 1 , which occurs whenever p < 0.5,
U (W + G ) p
then inequality [2.9] holds. Thus risk-averse individuals who have an
increase in wealth will be less likely to engage in high-risk criminal activ-
ity. Since the probability of apprehension is higher for certain activities,
such as murder, we now have a rationale for why wealthy individuals
typically commit nancially-motivated murder over other crimes com-
pared to poorer individuals. The wealthy are less likely to gamble than
the poor are when the odds are against them.

1. What is the difference between a black and a gray market? Will
making something illegal eliminate its desirability?
A black market is one which circumvents a law regulating the sale of a
product or making its sale illegal, whereas a gray market is the transfer
from one legal market to another without permission from the original
producer of the product.
2. Canadian authorities have called for an end to cross-border Internet
sales to the United States of prescription drugs arguing such sales
endanger the Canadian drug supply. Using what you have learned
in this chapter, is this a concern?
Not really. The problem is cost, not supply, especially since the national
and provincial governments pay for the cost of drugs. The critical prob-
lem is not one of shortages for the Canadian market in the case of drug
sales but rather higher prices since drug companies will no longer price
discriminate in a manner that favors the Canadian market. Of course,
higher prices may result in a reduction in quantity because of limited
government budgets but that is a problem of choice, not limitations on

supply.
3. Show that in the model given by equation [2.1], higher apprehen-
sion rates lead to lower crime.
The result follows directly using the same rationale regarding an
increase in the probability of imprisonment. Since the rst derivative
(marginal chance) of capture is positive, the impact is to raise costs for
the criminal.
4. Using equation [2.1], suppose there were no possibility of being
punished because ones lawyers were so good that they always got
you off without a conviction. Show that the criminal would then
ignore the likelihood of arrest.
If there were no possibility of punishment, c(y) would be zero. Thus, the
function would devolve into a simple maximization of revenue func-
tion. The persistent belief among Chicago gangsters in the 1920s prior
to Al Capones conviction for income tax evasion that they were above
the law led them to not resist arrest.

1. All other things being equal the wealthy will commit fewer crimes
because of declining marginal utility from wealth and prison terms
impact the wealthy more severely than the poor due to higher
income losses. However, wealthy defendants can afford better law-
yers who can reduce the likelihood of conviction or reduce the pen-
alty once convicted. Thus, the true impact of wealth on criminal
activity is indeterminate. To counterbalance their advantages in
court, prison sentences for the wealthy may be justied. Is this a
valid counterargument?
2. How would raising the smoking age to 21 affect the price of
cigarettes?
CHAPTER 3
Game Theory and the

Victim/Perpetrator Calculus
One issue with subjective probability is actions of the criminal inuence
probability of apprehension. A serial killer commands a higher proportion
of law enforcement resources than a serial purse-snatcher. In a sense, the
serial killer and law enforcement play a game of cat and mouse where
each move inuences the next set of moves.
Game theory is a method of analyzing strategic interactions between
different individuals, rms, or groups. Each such entity is referred to as
a player; each possible decision is known as a strategy; the amount each
player receives from playing his strategy against an opponents strategy is
called a payoff; and the actual interactions undertaken make up the
game. We represent the game by using a payoff matrix, (Table 3.1)
which is an n n (usually 2 2) matrix showing the payoffs from a variety
of strategies each player in a game may have from the strategies that he
employs.
The players are row and column, the strategies are top and bottom
(for row) and left and right (for column). Payoffs are read as (payoff to row,
payoff to column). If row plays bottom and column plays left, row receives
5 and column receives 4.
We call each combination of strategies a cell. There are four cells in the
example listed in table 3.1. The top left cell has the payoff of (2,1), so row
receives 2 and column receives 1 when row plays top and column plays
bottom. Each player can only determine his strategy and not the other
players. Row determines either top or bottom and column determines
either left or right. Row cannot force column to play a particular move and
column cannot force row to do likewise.
Yet sometimes the choice of what to play is obvious. If column plays
left, row will play bottom because the payoff for row from playing bottom
is 5, while playing top will only net row 2. If column plays right, row will
also play bottom because the payoff for row from playing bottom is 6,
while playing top generates only 3. When a strategy will always be
employed no matter what the other side does, it is referred to as a
dominant strategy. Therefore, row has a dominant strategy of bottom.
When a pair of strategies exists such that rows choice is optimal given
columns choice and columns choice is optimal given rows choice, we
have a Nash Equilibrium, named after John Forbes Nash, Nobel Laureate
in Economics in 1994. An example of a game with a Nash Equilibrium is
found in Table 3.2.
Using arrows, we can show how column and row will react to each
other. Suppose row plays top (Table 3.3). Column can choose either left
(payoff of 1) or right (payoff of 0). Since left has the higher payoff, column
plays left. We place an arrow showing left instead of right by putting a
left-pointing arrow between left and right in the top row.
We will now complete the diagramming of the game (Table 3.4). Next
we assume row plays bottom. Column will play right because 2 (the payoff
for playing right) exceeds 0 (the payoff for playing left). Assuming column
plays left, row will play top because 2 (the payoff to row of playing top)
exceeds 0 (the payoff to row of playing bottom). Similarly row, assuming
Table 3.1. Payoff Matrix

Column
Left Right
Top 2,1 3,3
Row
Bottom 5,4 6,0
Table 3.2. Nash Equilibrium

Column
Left Right
Top 2,1 0,0
Row
Bottom 0,0 1,2
GAME THEORY AND THE VICTIM/PERPETRATOR CALCULUS 67
Table 3.3. If Row Plays Top, Column Plays Left

Column
Left Right
Top (2,1) (0,0)
Row
Bottom (0,0) (1,2)
Table 3.4. Diagramming Game Strategies

Column
Left Right
Top (2,1) (0,0)
Row fl
Bottom (0,0) fi (1,2)
Table 3.5. Game with Only One Nash Equilibrium

Column
Left Right
Top (3,3) (2,2)
Row
Bottom (0,0) fi (1,1)
column plays right, will play bottom (because the payoff of 1 for playing
bottom exceeds 0 from playing top).
Notice how the arrows collide at the points top left and bottom right?
When the arrows collide onto a particular quadrant of the payoff matrix
means we have found a Nash Equilibrium. Thus, the two Nash Equilibria
in the aforementioned table are top left and bottom right.
Here is a game (Table 3.5) with only one Nash Equilibrium, that being
top left.
Table 3.6 is a game lacking a Nash Equilibrium. The arrows just go in
circles.
Table 3.6. A Game that Lacks a Nash Equilibrium

Column
Left Right
Top (0,0) (0,1)
Row fl
Bottom (1,0) fi (1,3)
In this case, no strategy dominates. Each individual players best

response is dependent on the other players actions and reects the inter-
dependence resulting from conict and cooperative strategic interaction.
Yet, even if a unique Nash Equilibrium exists, it may be preferred. Though
market mechanisms traditionally are seen to provide the best result for all
participants, game theoretic models predict some interactions may prove
less than benecial for all concerned. We now turn to one such game.
Prisoners Dilemma
In competitive market situations, there is little need to analyze strategic
effects. The best response from each player generates a Pareto Optimum.
A Pareto Optimum occurs when no one can be made better off without
making someone else worse off. It occurs when no further trades are
desired or possible. A choice to trade made between two individuals occurs
when each side values the option offered by the other person more than the
item that they are giving up in return. Thus both sides benet from trade.
If you did not benet, you would presumably not trade. On the other
hand, the prisoners dilemma is a game where the Nash Equilibrium is not
a Pareto Optimum.
Suppose Jeffrey and Angela are arrested at the scene of a crime. They
are taken to separate interrogation rooms to be questioned. Each is given
the opportunity to confess in exchange for a lesser sentence, a procedure
known as plea bargaining. Each knows if the other person confesses, the
other person will be a prosecution witness. Although the actual sentence
each will receive and whether each will be convicted is unknown, it is prob-
ably reasonable to expect having ones partner in crime testify against you is
a good indication you will be convicted. We will assume Jeffrey and Angela
know the following to be true: if both keep silent, the district attorney can
only convict them of trespassing, a misdemeanor requiring each to spend
1 year in jail. If both confess to breaking and entering, a felony, there will
be no trial and each will be sentenced to three years in prison. If one keeps
silent and the other person confesses, the silent one goes to prison for the
maximum sentence of six years, while the one who turns states evidence
will not be prosecuted as a reward for assisting the prosecution. What
happens?
Each of them reasons in the following manner: Suppose my partner
confesses, what should I do? If I confess, I get 3 years in prison. If I fail
to confess, I get 6 years in prison. Since 3 years in prison is better than 6
years in prison, I should confess if my partner confesses. Of course, I
dont know if my partner will confess. So, I need to think about what will
happen if my partner stays silent. If my partner stays silent and I confess, I
dont go to jail at all. On the other hand, if my partner stays silent and I
stay silent, I get 1 year in jail. Since not going to jail is better than going to
jail, I should confess. Therefore, since no matter what my partner does, it is
better for me to confess, I will confess all of the time. It is a dominant
strategy. Thus, both confess, so they both go to prison for 3 years. Notice
that if both refuse to talk, they receive just one year in jail, which is better
than if they follow their dominant strategies! What prevents them from
doing so is not only the uncertainty about what the other person will do
but also the incentive to defect from that strategy for their own gain. We
will show how this is solved using the arrows method in Table 3.7.
The Nash Equilibrium is for both to confess, while there is a Pareto
Superior position (both keeping silent). In this case, two individuals, both
Table 3.7. The Prisoners Dilemma

Angela
Confess Keep Silent
Confess (3,3) (0, 6)
Jeffrey
Keep Silent (6, 0) (1,1)
working toward their own best interests end up with a solution that is not
favorable to either of them. Indeed, altruism (keeping silent) is a Pareto
Superior solution but how do we get there when everyone is a utility max-
imizer? After all, the district attorney is not allowing a trade to occur.
Possibility #1: Alter the payoffs.
If we make confessing sufciently more expensive (by killing the
others family if they talk), we can ensure silence. Alternatively (or con-
jointly) we can make keeping silent more rewarding (by providing money
to the others family if they keep quiet).
Possibility #2: Repeating the game an innite number of times.
This works if we repeat the game an innite number of times and
employ the tit for tat strategy: we agree to stay silent as long as the other
person also stays silent. The most the other side can exploit you is one time.
However, in a one-shot game or in a game with a nite and known number
of rounds, one time is enough. If we know the game will be played
10 times, we will both defect (confess) on round #10 without retribu-
tion. Similarly, if you know I will defect in round #10, then you should
defect in round #9 but then since you will defect in round #9, I should
defect in round #8, etc.
Possibility #3: Repeat the game allowing it to end with a probability on
any round.
It turns out we dont need to do this an innite number of times, just a
potentially innite number of times. If it is possible that the game will con-
tinue each time, the fact it will eventually end does not preclude everyone
from acting as though it will not.
Reputation
Reputation can play a role in how criminals and victims interact. Victim-
ization surveys show those who are victims in the past are more likely to be
victims in the future. They are also more likely to take steps to reduce their
likelihood of victimization. Bullies in a playground pick on the weakest
kids to extort lunch money. They do this precisely because these are the
individuals who are least likely to resort to violence in kind. At the same
time, if violence must be used, the probability of success is greater against
weaker victims. The bully mentality may be to perpetrate an image of
toughness and machoism but underlying it is a different reality: the bully

can only be a bully so long as his image remains intact. The law of the
playground is the same as the advice given by Machiavelli to The Prince:
It is better to be feared than loved, if you cannot be both.
The reputation of being a bully allows a reduction in conict. If no one
has defeated him, he has an advantage others lack. Similarly, a reputation
of not paying aids the victim: the kid may get a black eye but if he persists
in not coughing up cash, the bully may nd it better to go after someone
unwilling to take the punishment.
Similarly, many companies in countries where kidnapping is rampant
refuse to negotiate with kidnappers while others persistently negotiate.
In each case, they develop a reputation. If you want to get back your
abductees, it might be worthwhile to negotiate but the effect is you only
end up with more abductees. Refusing to negotiate may mean dead abduc-
tees in the short-run but may lead to fewer abductees in the long-run.
Reputation also matters for the enforcement of oral extralegal contracts
at the heart of criminal activity. There may be no honor among thieves but
there are reputation effects. Someone who has a reputation as unethical in
her business dealings will nd that opportunities for cooperative criminal
activity will diminish, sometimes permanently. Payments to loan sharks,
after all, are often more forthcoming when the lender has a reputation of
extracting the proverbial pound of esh as an alternative nancing arrange-
ment for those who refuse to pay back what they owe.
Dynamic Games
Similarly, when you consider the interaction between burglars and property
owners, we see actions are mutually determined and not independent of one
another. We also see interactions are dynamic, not static. A typical response
to an increase in criminal activity is an increase in protective activity: more
burglar alarms and burglar bars are installed. The increase in cost associated
with trying to burglarize homes results in a drop in crime. However, that
drop in crime promotes an opposite effect: a decrease in protective activity.
This, of course, results in an increase in crime and the cycle is continued.
You might think adding police to the equation would make criminal
activity decline. Maybe, but maybe not. An increase in policing decreases
criminal activity and decreases protective activity by property owners. If the

decline in protective activity drops by a sufcient amount, you might actu-
ally get an increase in crime! Although extra policing will deter crime in the
short-run, it wont necessarily do so in the long-run. The effect will be
more money spent on the police but no greater level of safety.
Reporting a Crime
Catherine Kitty Genovese was returning home from work at around
3:15 in the morning of March 13, 1964. She had parked her car and was
less than 20 feet away from her apartment when she was attacked by
Winston Moseley, who repeatedly stabbed her while she screamed for help.
Several neighbors heard the commotion and turned on their lights and at
least one man, Robert Moser, called out to the attacker to leave her alone.
Moseley quickly left the scene but returned a few minutes later before
Genovese, who was now struggling to stay conscious, could open the
locked apartment door. A struggled ensued and again she cried for help.
As neighbors came to their windows, he left her again. He soon returned
and proceeded to rape her and completed the murder at 3:47 in the morn-
ing, earning the princely sum of $49 for his efforts. At around 3:50 in the
morning the rst call to the police came from Karl Ross who had been
debating whether to even make the call. Arriving less than 3 minutes later,
the police found the dead body of Genovese, which had been stabbed at
least 17 times. No fewer than 38 people witnessed or heard parts of the
brutal attack as it occurred.
Only one person reported the crime and he only did so after 35 minutes
had elapsed since the initial assault. This is characteristic of a free rider
effect. Many individuals felt someone else was going to report the crime so
why should they bother? A similar occurrence happened to me in Boston.
I heard a crash and when I went to investigate, I saw a bicyclist lying on the
ground motionless, the victim of an apparent hit and run. Not having a cell
phone, I ran off to nd a public phone, which I found about 5 minutes
later, and placed a call to the 911 operator. When I returned, the bicyclist
was still on the ground and a group of observers had surrounded him. By
the time police arrived a couple of minutes later and started interviewing
people, it became apparent the only 911 call came from me, even though
several of the bystanders had cellphones, saw the actual collision take place,
and gave the police a description of the suspect who had ed.
The free rider problem occurs whenever the individual believes they
can get something for nothing because someone else will pay the cost.
To understand how this works and why having more people at a crime
scene will actually lower the probability any one of them will report it,
consider the scenario given in Table 3.8. We begin with two witnesses:
Table 3.8. Reporting a Crime

Witness 2
Fail to report Report crime
Fail to report (0,0) fi (100,10)
Witness 1 fl
Report crime (10,100) (10,10)
There are multiple Nash solutions. With no dominant strategy for either
player, the best response depends on what each believes the other will do.
Both receive more benet than the cost of reporting the crime because if the
other person fails to report the crime, they will want to report it. With only
one witness, there is an incentive to report. Yet, as the number of witnesses
realizes that since all benet equally from having the crime reported but the
cost of reporting falls only on the individual who reports, it is not wise to
report crimes others will report. It only takes one call to bring out the police.
Multiple calls might only serve to clog up 911 lines, preventing other emer-
gency responses from occurring. Since each person rationally gures someone
in the crowd will report the crime, they each decide not to report. As the
number of individuals increases, the probability any particular one of them
will report the crime falls. Of course, the probability of multiple reports
increases with an increase in the crowd numbers as well.
Problem of Large Groups

As numbers expand, free riding becomes more of a problem since fewer
people nd it advantageous to contribute to public good, such as crime
prevention. A public good is one characterized by non-excludability and
non-rivalry. The former means no one who fails to pay can be excluded
from the public goods benets. The latter means when one person uses the
good, it doesnt diminish the ability of another person to enjoy it.
The action of reporting a crime is a public good: the benets (police
response) are provided no matter who makes the call and the resultant
investigation benets everyone in the public at large (with the exception
of the criminal!). If two people are neighbors, it doesnt matter which one
calls, both benet from the action undertaken. The fact that one benets
does not diminish the benet the other person receives.
Similar outcomes occur with other kinds of public good. A lighthouse
ensures ships at sea do not run aground; no one can be excluded from using
its services. The lighthouse cannot refuse service to one ship while simul-
taneously allowing a second ship to use its beacon. It provides the service to
both or neither (it is possible to turn the lighthouse off whenever contract-
ing ships are not around, but that is easily defeated by having the ship wait
around for a contracting ship to approach and tail that ship so as to benet
from the use of the lighthouse). The fact that one ship is using the light-
house does not diminish the benet that the other ship gets. Both benet
from not running their ships aground.
Everyone uses the benets, but not everyone pays the fair share. If it
were easy to get people to pay what they ought, there would be no need for
laws against tax evasion.
Sequential Versus Simultaneous Games

A sequential game is one in which the moves are revealed sequentially and
each player sees what the other player has done before deciding on a strat-
egy. Simultaneous games are those where strategies are revealed at the same
time. Rock, scissors, paper is a simultaneous game, while chess is a sequen-
tial game. So far we have dealt only with simultaneous games. However,
any simultaneous game can be transformed into a sequential one (and vice
versa). We begin with a simultaneous game (Table 3.9).
We transform this into a sequential game (Table 3.10) where Row plays
rst by having Row move rst and then showing Columns choices and pay-
offs based on what Row has chosen.
We proceed to solve the game by beginning with Columns moves
(Table 3.11). If Row plays Top, Column will play Left because his payoff
Table 3.9. A Simultaneous Game

Column
Left Right
Top (5,5) (3,3)
Row fl
Bottom (8,0) fi (0,8)
Table 3.10. A Sequential Game

LEFT (5,5)
TOP
COLUMN
RIGHT (3,3)
ROW
LEFT (8,0)
BOTTOM
COLUMN
RIGHT (0,8)
Table 3.11. Columns Choices

LEFT (5,5) *
TOP
COLUMN
RIGHT (3,3)
ROW
LEFT (8,0)
BOTTOM
COLUMN
RIGHT (0,8) *
* Columns Choices
of 5 is higher than the alternative of 3. At the same time if Row plays

Bottom, Column will play Right because 8 is higher than the alternative
of 0.
We then eliminate (or prune) the choices not made by Column
(Table 3.12).
Row chooses between a payoff of 5 (from Top) and a payoff of 0 (from
Bottom). Row thus chooses Top. A sequential game solution is a subgame
perfect equilibrium.
Even without a Nash equilibrium solution in the simultaneous game,
there is a solution in the sequential game. When Row moves rst, her
Table 3.12. Pruning the Game Tree

LEFT (5,5) *
TOP
COLUMN
RIGHT (3,3)
ROW
LEFT (8,0)
BOTTOM
COLUMN
RIGHT (0,8) *
* Columns Choices
choice will be Top and Columns choice will be Left. If there is no Nash
equilibrium, does it matter who plays rst? Let us switch the players so
Column goes rst and Row goes second. The only thing we will have to
change is we need to put the payoffs for Row second instead of rst in this
case. This means the payoff from Left and Bottom becomes (0,8) instead of
(8,0), as the payoff to Row is 8. This game is represented in Table 3.13:
Table 3.13. Who Moves First Matters

TOP (5,5)
LEFT
ROW
BOTTOM (8,0) *
COLUMN
TOP (3,3) *
RIGHT
ROW
BOTTOM (8,0)
* Rows Choices
Column is left with the choice between playing Left (and getting 0)
and playing Right (and getting 3). Column plays Right and Row plays Top
yielding 3 for each player. Yes, it matters who plays rst.
How does this relate to crime? A classic game is known as the kindly
kidnapper, (Table 3.14) who decides not to kill the person he has just
ransomed. Suppose a kidnapper successfully ransoms someone for
$100,000. What prevents them from killing the victim? The victim might
be blindfolded so as not to see the face of the kidnapper. If the kidnappers
identity is protected, it might make sense to release the victim, especially if
the police are less likely to pursue a case of simple kidnapping than of
murder. However, if the mask has come off and the kidnapping victim
can positively identify the kidnapper, it all changes. The kidnapping victim
Table 3.14. The Kindly Kidnapper

TURN IN KIDNAPPER (500,0)
RELEASE
VICTIM
KEEP SILENT (100,100)
KIDNAPPER
KILL (100,1000)
Table 3.15. Why the Kidnapper Isnt Kind

RELEASE
VICTIM
KIDNAPPER
KILL (100,1000)
can state all she wants she will not turn in the kidnapper. However, her
response is simply not credible. The kidnapping victim will identify the
kidnapper to the police.
Since the kidnapper knows the victim will turn him in (the victim
wants to recover the $100,000 that was paid in ransom), the kidnapper must
decide which is worse: killing the victim, resulting in a feeling of remorse
(remember the kidnapper is kindly), or letting the victim go free, which will
leads to the kidnappers capture. The kidnapper soon comes to the conclu-
sion the homicide is justiable, even if it does prove gut-wrenching. The
subgame perfect equilibrium is for the kidnapper to kill the victim (see
Table 3.15).
The kidnapper must nd a way to threaten the victim after releasing
her to ensure she doesnt go to the police. It must be a credible threat in that
doing it is in his best interest. There is an option: photograph the victim in
a series of compromising poses and threaten to release the photos if the
victim turns him in. The kidnapper has now committed another crime
(blackmail) but it is far less damaging than murder. Provided the victim
cares more about preventing the release of the photos than getting back the
ransom money, the scheme will alter the payoffs as shown in Table 3.16.
The payoff from turning in the kidnapper (500) is less than the payoff
from keeping silent (100), so the victim stays silent. The kidnapper com-
pares the payoff he gets from releasing the victim (100) with killing her
(100) and realizes it is better to release her.
Table 3.16. Blackmail Makes the Heart Grow Fonder

RELEASE
VICTIM
KIDNAPPER
KILL (100,1000)
The actual payoff does not matter: only rank order matters. If one
payoff exceeds another, the larger payoff wins. I could have used 100 or
100,000 as the payoff for the kidnapper. All that matters is that the kid-
napper receives more benet when the victim stays silent than when the
victim talks to the police and the kidnapper receives more benet from
killing the victim than if the victim talks. Similarly the kidnap victim must
receive more benet from being released than being killed (fairly obvious).
The victim must also receive more benet from going to the police than
keeping silent in the absence of incriminating pictures. Finally, the pictures
must alter the payoff so the victim no longer has an incentive to go to the
police (otherwise the kidnapper will still execute the victim).
There is another reason to not kill victims. If kidnappers kill too many,
everyone might gure out they arent getting back the victim, so why pay?
However, this reputation is a public good for kidnappers in general since
no one can identify the actual kidnapper, so we are back to an incentive to
free ride and kill the victim anyway.
Credible Threat
Corporate managers face a Prisoners Dilemma scenario in many countries
where corruption is rampant. If they make payments, they end up losing
far more in the long-run because they reinforce bad behavior on the part of
corrupt ofcials. Short-term gains extracted from making payments are
almost always cancelled out in the long-run by the reputation for being
a pushover. United States companies are faced with a dilemma: share-
holders demand quarterly results. So, going for the quick x is in their best
interest. In the absence of external force, each business bribes the ofcials
and all this will do is increase costs.
Businesses need something akin to what was needed by the kindly kid-
napper: they need their refusal to pay a bribe to be a credible threat. In this
case, they can turn to the government to be the external enforcement agent
to solve this coordination problem. In the United States, the Foreign
Corrupt Practices Act of 1977 does exactly that.
The act generally prohibits U.S. companies and individuals from
paying bribes to foreign ofcials to obtain or retain business. Enforcement
falls to the U.S. Department of Justice and the Securities and Exchange
Commission. Companies must keep strict accounts of transactions to for-
eigners to ensure bribes are not mischaracterized as legal payments. Paying
bribes can result in large nes for corporations, including disgorgement of
prots, and imprisonment and nes for individuals who are caught.
This legal instrument changes the calculus of business executives in
their interactions with foreign ofcials. While before the cost was the bribe
and the benet was the contract, now the cost includes possible imprison-
ment and nes by the U.S. government. Foreign ofcials may still ask for
bribes but U.S. businesspeople will be less likely to pay.
Criticisms of Game Theory

Three charges leveled against the use of game theory are worth noting. The rst
is it often fails to provide a solution or provides too many solutionsthere is no
one unique solution to each game. This is actually a strength. The issuance of
multiple solutions points out there are often coordination problems associated
with collective action. If we look at the reporting a crime scenario, there are
two solutions: both of which involve one person reporting the crime and the
other person deciding against doing so. However, if both individuals are iden-
tical, the determination as to who will report the crime is really decidable by
coin ip. We need some mechanism to enforce cooperation. It is similar to
arriving at a four way stop at the same time with another vehicle. More rules
are needed beyond whoever arrives rst gets to go rst.
A second charge is game theory promotes selshness. This is
unfounded. Neither economics nor game theory is inherently hedonistic.
The notion of a best strategy must come from some type of heuristic and
the logic of rational self-interest is the one followed. If an alternative
method of decision-making is used, different results can be generated using
game theory. Game theory is not inherently wedded to homo economicus as
long as the decision-making method is consistently applied.
The third allegation is the solutions follow directly from the specica-
tions. This is true. If the specications are faulty, the games will be such as
well. The prisoners dilemma results in a situation where both players con-
fess yet both do worse than if they keep quiet. Invariably there are those
who will cooperate even if the other side constantly defects. This does not
mean game theory is broken. It merely suggests the actual payoffs of a
particular individual are not those generated in the game and there are
additional factors the modeler failed to take into consideration that cause
reality and the model to diverge.

1. You and a stranger witness a person bleeding to death. You both
know the other person has seen it as well. Design a game that mod-
els whether you call 911.
This particular game form is called chicken in game theory
(Table 3.17) and it can be used to model the response of the neighbors
to the Kitty Genovese murder.With more than two people, we call this
game the volunteers dilemma. The optimal response is to have some-
one call. What may happen is neither will call.
Table 3.17. Game of Chicken

Other person
Call Do not call
Call (1,1) fi (0,2)
You fl
Do not call (2,0) (1,1)
2. How does the Maas code of silence, which promises retribution

against family members of Maa members who rat on other
Maa members, work to prevent the prisoners dilemma? What
must the government do to counter this?
It raises the cost or lowers the benet of defection (i.e., confessing).
The government must counter by increasing the benet of confessing (via
techniques like witness protection programs for the person and his family
or increased payoffs). A second option is to raise the cost of staying silent
by increasing penalties if someone is charged with being part of a crim-
inal organization.

1. Discuss how a simultaneous game might turn out differently if the
players were able to move sequentially (rst one moves and then the
other, with the latter being able to see the move of the former in
advance of his move)?
2. The United States always tries to get other countries to follow its
lead in the so-called drug war. This policy does not consider the
legitimate sovereign rights of foreign governments to set their own
policies. The government of Jamaica, knowing that legalization of
ganja (marijuana) would be benecial from a public policy stand-
point if all other things remained the same, would like to change
its laws so that ganja possession and production are allowed. The
payoffs from each policy to both countries are represented in the
game shown in Table 3.18.
a. Determine all Nash Equilibria for this game.
b. If the United States moves rst, draw out the sequential game
tree and nd the subgame perfect equilibrium.
c. If Jamaica moves rst, draw out the sequential game tree and
nd the subgame perfect equilibrium.
Table 3.18. Economic Sanctions

USA
Impose sanctions Free trade
Grow Ganja (0,50) (200,25)
Jamaica
Criminalize (100,50) (0,0)
CHAPTER 4
Organized Crime
In the United States, organized crime is, even with the introduction of the
Racketeering, Illegal, and Corrupt Organizations (RICO) Act, the bane of
law enforcement. It has been accused of turf wars, leading to the slayings
of innocent bystanders, and is a source of corruption in the civil service of
various municipalities.
Organized crime tends to ll in where government fails to govern.
Repressive regimes rarely have problems with organized crime. The Russian
Maa only gained prominence after the collapse of the Soviet Union and the
Taliban was highly successful in controlling the opium trade in Afghanistan.
At the same time organized crime often works with corrupt government
ofcials in a self-reinforcing web of corruption.
Organized Crime as Monopoly

In analyzing organized crime, it is helpful to relate it to what we know
about the organization of rms. Organized crime is simply a means by
which distribution of illegal goods and services is managed. When crime
is organized, a monopoly or near-monopoly on particular goods or service
is maintained. This monopoly may take the form of a single entity con-
trolling a geographic region (the infamous Bloods and Cripps of South
Central Los Angeles come to mind) or it may be a collection of separate
crime families who organize as a cartel. La Cosa Nostra (the Sicilian
Maa) is one such example.
With a monopoly (or an effective cartel), the sole provider of the eco-
nomic bad (prostitution, gambling, drugs, etc.) is organized crime.
Monopoly is maintained with a barrier to entry and the fact there are no
close substitutes available in the legal sector. There was little-to-no involve-
ment of organized crime in production and distribution of liquor prior to
Prohibition. By passing a law making the sale of liquor a felony (with only
minor exceptions for medicinal and sacramental purposes), the U.S.
government created a major barrier to entry: only those willing to be in an

illegal market could compete. Illegal markets are conducive to monopoly:
there is no ability to openly advertise ones services so one spreads knowl-
edge by word of mouth. Yet word-of-mouth advertising has an increased
probability of detection. Thus, many criminals pay off law enforcement to
look the other way. This protection is specic to the organization. A cop in
the pay of the Gambino crime family will still enforce the law against the
Luciano crime family. There are high entry and maintenance costs, includ-
ing payment of bribes. In addition, entering the market entails the possi-
bility of being killed.
In 1937, Nobel Prizewinning economist Ronald Coase published one
of his most inuential papers, The nature of the rm.1 He noted that if
the market were as perfect as economics sometimes portrays it to be, there
would be no need for rms. Firms function more as command-and-control
centers than market systems. Marketing does not contract with data pro-
cessing, shipping does not buy products from production, and accounts
payable and human resources do not have competitors nor can they with-
draw their services and sell to other agencies. If the market were perfect, its
organic nature would create a system where entities working only for their
own self-interest would end up with a solution that also promoted the
interests of society. Yet, managers within a rm do not direct actions to
promote departmental interests but rather work for the interests of the rm
writ large, even to their departments detriment. Rather than allowing
deployed resources within a rm via a price mechanism, resources are
directed by a command-and-control system, not unlike what is found
under communism.
According to Coase, rms arise to deal with transaction costs that make
the market mechanism cost-prohibitive. The principal cost associated with
illegal transactions is the very illegality itself. Business relationships do not
survive beyond initial transactions in such markets, so there is a serious inter-
est asymmetry if a partner is apprehended by the police. To reduce the pos-
sibility or degree of punishment, naming names of criminal associates is a
highly protable strategy. Thus organized crime tends to arise any time
when more than a small cadre of criminals is needed to carry out an activity.
Division of labor results from specialization and distribution of tasks
arises from comparative advantage. These two phenomena generate the
ORGANIZED CRIME 85
need to trade, a uniquely human activity. Without differences between

individuals in their respective talents or endowments, there would be no
need to trade and no advantage in it.
There are still some activities where having more than one person is an
advantage. A jewel thief will work with an equally skilled jewel thief to steal
from a different area of a store when it is impossible to cover both areas in
the allotted time and the thief does not know where the more valuable
jewels are. Yet, when one cannot do it as efciently as another, there are
gains from doing what each nds most efcient.
Take the example of a jewel thief and a safecracker. The jewel thief knows
what diamonds to steal and which to leave behind. The safecracker can at best
open a safe. Each task happens sequentially and each individual looks out for
the police when not handling his appointed task. Suppose a jewel thief can
steal $10,000 worth of diamonds in a minute. A safecracker opens a safe in
3 minutes. The jewel thief takes 5 minutes to crack the safe and the safe-
cracker can steal $4,000 worth of diamonds in a minute. With just 6 minutes
before police arrive, having a skilled jewel thief and a safecracker is preferable
to either two safecrackers or two jewel thieves (or a jewel thief or safecracker
working alone). The lone jewel thief steals $10,000 worth of diamonds given
the ve minutes required for the task of opening the safe. The lone safecracker
would steal $12,000 worth of diamonds. The would-be thieves face an addi-
tional problem. When two safecrackers work together, one could only have a
lookout during the safecracking (having to crack a safe does not speed up the
process) and they jointly could only steal $24,000 worth of diamonds. They
would be no better off than if a lone safecracker did the job (assuming pro-
ceeds are split equally). Similarly, when two jewel thieves work together
(again with a lookout only during the safecracking), they could steal
$20,000 worth of diamonds but would do no better than acting alone after
splitting the proceeds. However, if a jewel thief and a safecracker work
together, they could clean out either $30,000 if the safecracker acted as a
lookout after opening the safe or claim $42,000 if they are willing to risk not
having a lookout. They do better working as a team that splits the job than by
contracting with similar individuals or acting alone. This is an example of
absolute advantage, where one person produces at an absolutely lower cost
than the other. Jobs where tasks cannot be done simultaneously are best han-
dled on this basis.
Consider a task that can be carried out simultaneously, production of

false identication. Marjorie can generate a document in just 1 hour but
excels at producing holographic images that must accompany them, creat-
ing one in 2 hours. Sue creates a hologram in 5 hours and a document in
2 hours. If the goal is to produce the greatest amount of false documents
and the two processes are independent of one another, each specializes in
the task in which she holds a comparative advantage. Marjorie can create
two documents for every hologram, while Sue can create 2 documents
for every hologram. The opportunity cost of Marjorie creating a hologram
(what she gives up in exchange for creating it) is 2 documents and Sue has
an opportunity cost for creating a hologram of 2 documents.
Marjories opportunity cost is lower than Sues for creating a hologram.
Even though Marjorie does both tasks better than Sue, Marjorie specializes
in holograms and Sue specializes in documents.
If interdependent tasks are involved in the production of a particular
commodity, persons who hold a comparative advantage but lack an abso-
lute advantage in either task will spend all of their time on the task for
which they hold the comparative advantage while the person who holds
both a comparative and absolute advantage might nd himself or herself
engaging in both tasks. If the goal is to create as many documents as pos-
sible in a 40-hour week, Marjorie can create 20 holograms or 40 docu-
ments. Sue can create 8 holograms or 20 documents. In this case, the
two can create 20 documents (with holograms) in 40 hours. There is no
other combination of labor that will generate as many documents in the
40-hour period. Indeed, if Marjorie tried to do everything herself, she
could only create 13 documents (it takes her 3 hours to create each doc-
ument, complete with hologram) and Sue could only create 5 documents,
for a total of 18.
However, cooperation in criminal activity is conspiracy and has addi-
tional penalties prescribed by law. Criminals have little incentive beyond the
immediate goal to maintain cooperation. We are back to a prisoners dilemma.
Criminal organizations solve the prisoners dilemma and thus increase
cooperation. There is no honor among thieves but when someone
has a hit man assigned to wipe out ones family if one talks, there is a pow-
erful incentive to keep quiet no matter what deal is offered by law
enforcement.
ORGANIZED CRIME 87
Solving the Prisoners Dilemma

Organized crime has a few more strategies to solve the prisoners dilemma
discussed in the previous chapter. First, the two criminals could sign a contract
= guaranteeing they will not talk. If there is a system that can be used to guar-
antee that contract (extrajudicial or judicial), the likelihood of cooperation will
increase. A second possibility is to alter the payoffs by promising to take care of
the family of the person who remains silent by giving a large cash infusion.
A nal method is to threaten to really take care of the family by harming, or
even killing, them. All of these are used by organized crime. Since criminal
organizations continue beyond the immediate job and people carry out actions
as a sort of mutual aid society for transgressors of law, the effect is to make the
game an innite one. It seems that it can never leave the family. The statement
just when I thought I was out they pull me back in that Michael Corleone
said in Godfather III hangs over those in organized crime in more ways than one.
Economies of Scale and Scope

Large organizations have economies of scale and scope unavailable to
smaller enterprises. A small ring of thieves connes itself to limited targets
and lacks nancial resources to pull off large heists. Increased size means
increased division of labor. While a single thief must do everything herself,
two criminals can specialize in different tasks accomplished in tandem or
sequence. As numbers increase, criminals can not only specialize in differ-
ent tasks but can also move into other areas of crime: prostitution, drugs,
gun running, and gambling might make themselves available to larger
organizations. These can be mutually reinforcing: the ability to acquire
drugs can lower the cost of prostitution. By getting prostitutes hooked on
drugs supplied by the criminal enterprise, the group can increase protabil-
ity through what is known as economies of scope due to are cost-savings
resulting from joint production of commodities.
Larger size means violence takes on a whole new dimension. Special-
ized hit men can be attracted to the payroll and their expertise in dealing
with problems, which otherwise prove intractable, can assist in the devel-
opment of alibis. While a man attends a charity ball put on so conveniently
by the local police department, he cannot be simultaneously murdering his
wife to avoid paying alimony or child support in a divorce settlement.
The Government-Organized Crime Connection

The government objects to extrajudicial violence but criminal organiza-
tions tend to originate where government has an inability to fully exploit
its legal monopoly over institutionalized and state-sanctioned violence.
The Sicilian Maa developed due to a power vacuum in the region when
the legitimate government could not or would not enforce contractual law.
When a government makes a good or service illegal, it ceases to enforce
related contracts. Since all transactions are fundamentally contractual obli-
gations, even if met at the time of the striking of the bargain by delivery of
the goods upon cash exchange, there is no mechanism in the illegal good
market to enforce standard business practices. An alternative mechanism is
developed to ensure relationships are settled via contractual means
enforced by extrajudicial processes.
The government may try to re-exert control by breaking the back of the
Maa. In the late 1920s, Cesare Mori established the Iron Prefect in Sicily
under Benito Mussolinis Fascist regime. Paralleling a military action
instead of a police one, Mori applied methods such as torture and kangaroo
courts to ensure those who were accused by the state were convicted. He
succeeded in bringing the Maa to its knees and then broke its kneecaps,
although at an enormous cost in terms of convictions of those who had
nothing to do with the Maa. The actions caused a mass exodus to Canada
and the United States, where the Maa quickly established itself as a force
during Prohibition. His success eventually led to his undoing. By taking on
individuals who had ties not only with the Maa but with the Fascist party,
he proved to be a thorn in Mussolinis side. Not being able to eliminate
Mori owing to the following created through the Iron Prefects reported
exploits, Mussolini did the next best thing: declaring victory over the
Maa and having Mori kicked upstairs to serve in the Italian Senate.
The United States acknowledged the Maas power in the 1940s,
working out a deal with imprisoned Maa don, Lucky Luciano. Using an
understanding with the Longshoremens Union, Luciano ensured
through extralegal means that Nazi saboteurs did not affect New York har-
bors and he provided crucial connections for the U.S. militarys invasion of
Italy in 1943. He was paroled in 1946 on condition he accept deportation
to Sicily. After removal of the hated Fascist regime, the Maa regained its
ORGANIZED CRIME 89
preeminent position as powerbrokers on the island. Similarly, the Maa

was recruited by the CIA in its attempt to overthrow Fidel Castro. It seems
the notion of the maosos as bastards but at least theyre our bastards
captured the spirit of the American governments love-hate relationship
with La Cosa Nostra.
This government-organized crime nexus that developed in Italy and
the United States is commonplace. Bureaucratic red tape provides oppor-
tunities for corruption and organized crime exploits this. The Yakuza in
Japan paralleled the development of the Maa in Sicily. Organized around
street peddling and gambling, the Yakuza were often in league with the
government during the Tokugawa era, recouping costs associated with
public works contracts. Before World War II, the Yakuza acted as enforcers
for ultranationalist aims. During the war, the government turned on the
Yakuza, so the group allied with the American occupiers following the sur-
render of Japanese forces in 1945. The Americans saw the Yakuza as a
hindrance but, with severe rationing, the Japanese populace looked to the
criminal syndicates to distribute food through the black market. With the
widespread removal of government ofcials, a power vacuum was created
and organized crime stepped in to reestablish order, even if not under the
guise of law. This simply caused the bloodletting to spill over from within
the Yakuza brotherhood to general society and a mob war ensued. Yoshio
Kodama, a former rear admiral in the Japanese navy released under a gen-
eral amnesty declared in 1948 for many war criminals, united previously
divided Yakuza factions. By stopping the violence and having the Yakuza
combine, he transformed it into a cartel not unlike the Maa. In so doing,
his ability to inuence Liberal Democratic Party legislation increased
immeasurably. Acting against communist leaning organizations, such as
the Japanese Red Army, the Yakuza had a cozy relationship with the gov-
ernment until LDP kingmaker Prime Minister Noboru Takeshita
resigned, after his approval rating had plunged to just 4%. Both Takeshita
and Kakuei Tanaka, whose implication in a scandal involving a $2.1 mil-
llion bribe by Lockheed Corporation in 1974 rst brought the
governments relationship with the Yakuza to light, were considered major
wheeler-dealers in the long-ruling party. Takeshitas resignation in the
Recruit Scandal brought down the LDP and ushered into ofce the frac-
tured opposition in 1993.
One useful aspect of being involved in organized crime is one can lever-
age the power of the state to reduce competition. When nascent rival orga-
nizations attempt to encroach on their turf, a few well-placed phone calls
will often mysteriously appear at police headquarters and the market
entrant is quietly dispatched and denied entry. This assistance does not
go unappreciated by the police. Beat cops are frequently courted and paid
off with monetary bribes and assistance is solving non-organized crime as a
policy to ensure a successful criminal enterprise. Being in a criminal orga-
nization may enable criminals to increase payoffs from crime and decrease
losses.
The need to reduce transaction costs motivates the formation of such
organizations. Playing on the concept of family, the development of elabo-
rate rituals, intermarriage within the group to interlock relationships, and
the extension of tentacles of the criminal organization into every aspect of
the lives of its membership enables it to build trust in an inherently low or
no-trust business. It may be one keeps ones friends close and ones enemies
closer but these relationships allow for exertion of leverage on an unparal-
leled scale. When your brother-in-law is also your partner in crime, it is more
difcult to turn states evidence and when it is politely suggested your elderly
mother might become fall victim to a tragic accident, you tend to cooperate.
The pronouncement of Sean Connerys character on how to deal with
Capone in the movie, The Untouchables, could just as aptly refer to the way
you deal with all maas: He pulls a knife, you pull a gun. He sends one of
yours to the hospital, you send one of his to the morgue. Thats the Chicago
way.
One interesting twist is criminal enterprises no longer work simply in
the shadow realm. They own legitimate businesses as well. The romantic
notion Bugsy Malone wanted the Maa to go legit through establishing a
beachhead of legal gambling in Nevada is only partially false. Producing
legal income serves as an effective defense against the tax evasion charges.
Capone was brought down for living like a king while never paying income
taxes. By producing a stream of legal stream of income, these businesses
provide two functions: rst, they assist criminal organizations in their
attempt to legitimize their prots and, second, they allow for money laun-
dering of various forms.
ORGANIZED CRIME 91
Price Discrimination
However it achieves it, organized crimes principal characteristic is its
monopoly power over an illegal industry or industries within a well-dened
area, whether as a single entity or a group of entities working as a cartel. If it
operates as a cartel, there is the possibility of cheating to gain higher
prots. This later form is probably more characteristic of organized
crimes structure but, for the purpose of this section, we will assume
enforcement of agreements both tacit and explicit regarding quantity and
pricing of illegal goods and services can be accomplished whether through
extrajudicial negotiation or by the ultimate in negotiating tactics: murder
and assassination.
It shares with all monopolies the fundamental characteristic that to
ensure high protability, it is often necessary to engage in some form of
quantity restriction. The irony is organized crime might reduce crime,
leading us to speculate the absence of organized crime, that being disorga-
nized crime, might be more painful in the long run.
To understand this, we return to price discrimination rst broached in
Chapter 2. There are four types of price discrimination: perfect price dis-
crimination (or price discrimination in the rst degree), second degree
price discrimination characterized by quantity discounts, third degree price
discrimination characterized by group discounts, and the hurdle model of
discrimination, found where a barrier is placed in front of individuals who
must decide to hurdle the barrier to get the discount.
Under normal, non-price discrimination, circumstances, a single price
is paid by all individuals for the same product. Price discrimination changes
this. With perfect/rst degree price discrimination, everyone pays a different
price, called the reservation price, equal to the maximum possible price each
is willing to pay. Normally it is difcult, if not impossible, to establish such
prices, but the tactics of organized crime make it more likely such a favor-
able determination can be made. If this occurs, organized crime and dis-
organized crime have identical results from a quantity standpoint but the
overall transfer of wealth from customer to producer is far more pro-
nounced. Consumer surplus (the difference between what a customer is
willing to pay and the price paid) evaporates as the benet is transferred
to the monopoly organized crime rm (Figure 4.1).
Consumer surplus
Price
Demand
curve (also
Demand curve price)
Perfect competition Perfect price discrimination
Figure 4.1. Comparing perfect competition with perfect price

discrimination.
Second degree price discrimination occurs when a criminal element pro-

vide discounts for large-scale purchases. The more you buy, the bigger the
discount. Such discounts are only second degree price discrimination when
there is no reduction in cost for providing the good. Giving a quantity dis-
count for transportation is not price discrimination when it costs only 50%
more to transport twice the product. Price discrimination revolves around
charging different amounts for items that cost the rm the same amount.
Third degree price discrimination occurs when the criminal rm pro-
vides different prices to people based on membership in a group. In a shake-
down operation, the Maa might charge a mom and pop store less than what
it charges a law rm since the gangsters will rationally conclude the store is
less able to pay. The idea is not to force these stores out of businessit is to
collect a piece of the action.
Finally, criminals might employ a hurdle model of discrimination.
Favored customers might be get a password to enter a speakeasy and get a
better price. Saying Tony sent me might result in a big discount on a
cocaine shipmentor a watery grave.
When price discrimination cannot be undertaken, monopolies limit
overall quantity produced. Firms operate where marginal revenue equals
marginal cost and this reduces output when compared with perfect compe-
tition (Figure 4.2).
Where nd the intersection of marginal cost and marginal revenue to
nd the quantity output by the rm. We then go up from that position to
the demand curve to determine the price. If price is higher under
ORGANIZED CRIME 93
MC
Monopoly
price
Competitive
price
MR = MC
MR Demand curve
Monopoly Competitive
quantity quantity
Figure 4.2. Monopoly versus perfect competition.
monopoly and output is lower, it stands to reason the same is true whether
the rm is a legal or an illegal combine. As such, the monopolization of
certain segments of criminal activity will actually reduce criminal activity
over a competitive environment. RICO is, therefore, a foolish endeavor.
In the real world, the previously discussed economies of scale and
scope, as well as the ability of organized crime to price discriminate, will
cause an increase in the amount of crime over the static analysis given ear-
lier. In the case of economies of scale and scope, this is because the cost
structure of criminal organizations operating under economies of scale or
scope lowers both overall and marginal costs. As the marginal cost of crime
falls, more crime is supplied. In the case of price discrimination, consumers
end up paying higher prices than they otherwise would, causing marginal
revenue to rise. Once again, more crime is supplied. It might be that the
output of crime will actually exceed that of the competitive sector once all
factors are accounted for: the enforcement of RICO statutes might be an
economically rational choice right after all!
To ensure continuation of the monopoly either as a single rm or as a
cartel requires large-scale expenditure of resources to preclude entry of
new criminal organizations. This is accomplished through violence or even
cooperation with the police force. However, there is now evidence
organized crime may be breaking down. Older taboos against killing
non-organized crime elements are weakening and the enactment and
enforcement of anti-racketeering legislation has led to a precipitous decline
in the ability of old-line criminal gangs to succeed in their goal of domi-

nance in various criminal activities.
Toward a Theory of Extralegal Justice

A system of extralegal justice in settling disputes helps explain the prev-
alence of organized crime, especially in gambling, prostitution, loan shark-
ing, and drug dealing. During Prohibition, it was not uncommon to set up
a tab for patrons of speakeasies, those establishments that served various
libations of an alcoholic nature. Both patrons and bar owners had incen-
tives to cheat. The patron might run up the tab and not pay, thus getting
his booze for free, while the bar owner might water down the drinks to
decrease costs. In towns that were small but not so small as to preclude
competition, patrons who failed to honor their tabs would be cut off from
their liquor supply while speakeasies that watered down drinks would nd
themselves losing customers to more honest establishments. However, in
larger cities, such as Chicago and New York, it was possible for both parties
to cheat. There was less need for repeat business due to the number of
people who had not yet frequented the speakeasy and it was easier to main-
tain anonymity in a big city than in a small town where everyone knows
your name. A poor reputation could follow you but without a legal avenue
for the dispensing such advice, it often goes unsaid in illegal markets for a
longer period than in legal ones, allowing at least transient customers and
y-by-night establishments to enter the market and subsequently run off.
Reputation only matters to those for whom, well, reputation matters.
When goods and services are legal, issues of false advertising and dead-
beat customers are settled through a court process in which one party sues
the other for non-provision or nonpayment as the case might be. We can
set up a game using what we learned in the previous chapter to address this
question. We begin by looking at a baseline for both customer and speak-
easy. If the speakeasy waters down the drinks and the customer pays noth-
ing for the drinks, neither receives any benet. We call this payoff 0 for the
sake of discussion. If the speakeasy serves alcohol and the customer pays for
his drink, both achieve the result they expect. We call this payoff 1. Work-
ing from that, the speakeasy, to have an incentive to water down the drink,
must see its payoff from doing so exceed the payoff it receives from serving
ORGANIZED CRIME 95
alcohol. The bar has lower costs when it dilutes the drink and yet expects to
receive the same amount of income. The exact amount of the payoff is
immaterial for this analysis but it must be greater than the payoff of
1 received by the speakeasy from serving alcohol provided the customer
pays. If the customer fails to pay, the speakeasy must lose more by serving
alcohol than it would if it were to water down the drink. The customer who
fails to pay realizes a greater benet than if he pays. Since this game is played
simultaneously, neither strategy is revealed before the other side commits.
We assume the customer attempts to pay for the drink using counterfeit bills
and enters the establishment with this intention (Table 4.1).
Without enforcement, the result is another prisoners dilemma
(Table 4.2).
Though both customer and speakeasy would do better by serving alco-
hol and paying, neither has incentive to do so, leading to the Pareto Infe-
rior result of the speakeasy watering down the drinks and the customer
paying with counterfeit bills. If we have a system of contract enforcement,
both can be led to the Pareto Superior result. Since this cannot be by the
Table 4.1. Watering Down the Drinks

Customer
Fail to pay Pay
Water down (0, 0) (a, b)
Speakeasy
Serve alcohol (c,d) (1, 1)
a > 1, c < 0 (serving alcohol costs more than watering down the drinks)
b < 0, d > 1 (failing to pay is better than paying)
Table 4.2. Another Prisoners Dilemma

Customer
Fail to pay Pay
Water down (0,0)* (a, b)
Speakeasy
Serve alcohol (c, d) (1, 1)
* Nash Equilibrium
courts, extralegal justice is necessary. Every time the speakeasy waters down
the drink or the customer fails to pay, organized crime extracts a penalty
against them, which we designate P. If the penalty is large enough (i.e., it
overwhelms the extra benet obtained by cheating), the result is both sides
will act honestly (Table 4.3).
Therefore, provided that P > -c and P > d - 1, we get the result as shown
in Table 4.3.
It might be easier to see this if numbers were attached to the game
(Table 4.4).
Attaching penalty of 0.75 for noncompliance leads us to the optimal
solution of serving alcohol and having the customer pay (Table 4.5).
Table 4.3. Enforcing an Agreement

Customer
Fail to pay Pay
Water down (0-P, 0-P) (a-P, b)
Speakeasy
Serve alcohol (c,d-P) (1, 1)
Table 4.4. Putting Numbers on the Game

Customer
Fail to pay Pay
Water down (0,0)* (1.5, 0.5)
Speakeasy
Serve alcohol (0.5, 1.5) (1, 1)
Table 4.5. Attaching a Penalty for Noncompliance

Customer
Fail to pay Pay
Water down (0.75,0.75) fi (0.75, 0.5)
Speakeasy fl fl
Serve alcohol (0.5, 0.75) fi (1,1)*
* Nash Equilibrium
ORGANIZED CRIME 97
One caveat existsthe protection of this extralegal system is, like pro-
tection offered by the government for legal transactions, not offered in a
market setting. Government may hold a monopoly on sanctioned violence
but organized crime has sufcient power to dispel any myth unsanctioned
violence cannot be easily and forcefully applied. Still these monetary costs
will be less than what would be exacted from individuals who refuse to pay.
Organized crime will make them the proverbial offer that cannot be
refused, not because terms are so desirable but rather because failure to
agree results in effects that are most denitely undesirable.
The game we disclosed above is somewhat simplied by assuming the
penalty is the same for both sides: frequently, it may not be. In addition,
for some individuals, the penalty exacted will not ensure compliance. The
penalty is only extracted upon detection and if one believes the probability
of detection is low or the benets from cheating relative to the penalty end
up being greater in the mind of the individual speakeasy or customer, that
particular side will still defect and the penalty will have to be applied.
Trust
In most market transactions, trust is important. Lack of trust limits the size
of criminal enterprises. As organized crime operates as a cartel, cheating
may be rampant.
There seems to be a division of markets based on geography that has
come to permeate organized crime. Until recent federal prosecutions under
the RICO Act made separation of federal from local jurisdictional crime no
longer protable, domestic interests would rarely involve themselves in areas
exposing them to federal prosecution such as narcotics or gun running, pre-
ferring instead the safer avenues of prostitution, gambling, and providing,
according to Sterling,2 a license to foreign interests to take on criminal activ-
ities that would initiate federal prosecution. In such ways, criminal interests
in the United States operate a reverse franchise operation, allowing establish-
ing of enterprises in their territory that go beyond the scope of their normal
operations. The notion of a Maa code that precluded them, in large part,
from getting involved in guns or murdering civilians or law enforcement
ofcers was ction created for Hollywood consumption. The reality is such
activities would increase the likelihood of getting caught and successful
prosecution by federal ofcials who, in the 1920s, had been labeled as

untouchables because of their supposed incorruptibility.
Organized crime, instead, operates on the edges of respectable society,
straddling it by being engaged in both criminal enterprises and seemingly
legitimate ones, to provide money laundering services for the illegally accu-
mulated. This provides an afrmative defense against accusations of
income tax evasion and also enables their leadership to operate openly as
respected members of the business community.
The question of trust hangs over everything. Family relations may
strengthen these bonds, but they still remain weak, as evidenced by the
threat of violence. The key to success is less trust than the creation of incen-
tives to make cooperation easier. Criminal enterprises are kept small and
economies of scale are only exploited through mutual cooperation with
other enterprises. Organized crime is really a series of interlocking organi-
zations with a common purpose but no common master. Competition is
bad business because it reduces protability and so it is kept to a mini-
mum. The need for incentive compatibility with the goals of the organi-
zation is exemplied by the following:
No one steals from the Maa or so one would think. Each day, bagmen
would drop off money to be counted and stored but the Maas chief accoun-
tant noticed a difference between what was supposed to be collected and what
actually coming and he reported to the Godfather he suspected his twin brother,
Sam Silent, had pocketed the money.
Sam was an illiterate deaf mute. This is an advantage if he were ever
caught by the police or another family, but the Godfather wanted to know what
happened to all of the money. How do you get answers from someone who
cannot communicate with you? Luckily, the accountant had an answer: the
two brothers had developed a secret language so he could tell the Godfather
what Sam was saying.
To catch Sam in the act, the two distributed marked bills to various busi-
nesses and asked them to use those bills to pay that weeks extortion payment.
When he called Sam into his ofce the next week, the Godfather spoke
slowly and said, Look, I know you have been skimming money from the
shakedowns.
Sam swiftly shook his head and moved his hands, which his brother told the
Godfather meant, Not at all. I handed in every single cent.
ORGANIZED CRIME 99
The Godfather ordered Sam to empty his pockets and found three marked
bills.
Where did you get these bills and what did you do with the rest of my
money?
Sam gestured some more and his brother relayed that he had stated, I do
not know what it is that you are talking about. This is simply my weekly pay.
The Godfather was really upset now and pulled a gun and pointed it at
Sams head. Tell me again, where did you hide the money you stole from me?
Sam started to sweat and quickly signaled to his brother, Please brother,
tell him the truth. You gave me those bills.
The accountant replied his brother had said, Okay I stole from you but
you dont have the guts to pull the trigger.
Although blood may be thicker than water, money might trump all else.

1. Tit for tat is effective for innite repeated prisoner dilemmas but
games are never repeated innitely. Why does this strategy work, if
at all, in the real world?
So long as no one knows when the game will end, it is structurally the same
as an innite game. The key is not to know how long the game will last.
2. How does the Maas code of silence, which promises retribution
against the family members of Maa members who rat on other
Maa members, work to prevent the prisoners dilemma? What
must government do to counter this?
It raises the cost or lowers the benet of defection (i.e., confes-
sing). The government then must increase the benet of confessing
(through techniques like witness protection programs for the person and
his/her family or increased payoffs). A second option is to raise the cost
of staying silent by increasing penalties if someone is charged with being
part of a criminal organization.

1. Is organized crime benecial to society when compared with disor-
ganized crime?
2. Going back to the manufacturing of IDs discussed in this chapter,

suppose that Victor goes to school and learns how to generate holo-
grams better so that it now takes him 4 hours to generate a hologram
(and 2 hours to design a document). What will occur then? (Hint:
neither has a comparative advantage).
CHAPTER 5
Victimless Crimes
Why do we have laws against certain activities? That answer may seem
obvious, but it isnt. To understand why, we rst identify the three main
categories of crime:
1. Crimes against society (also called victimless crimes)

2. Crimes against property
3. Crimes against persons (also called violent crime)
Each entails certain costs to society and others but the nature of these
costs differs across types. Crimes against persons, including rape, murder,
assault, and various gradations of each, impose a cost to the individual
harmed but also to society through the loss of future productivity. If some-
one is murdered, they will not be able to work again; this reduces the ow
of goods and services, both market and non-market, that would have
otherwise been produced. This is not a callous observation: even those who
are not in the labor force are productive in some sense through benets
others receive from their presence. A retired great-grandfather produces for
his progeny a stream of enjoyment that would be missing upon his death.
However, societal losses exceed just that, for the value of a life is more than
simply ones productive capacity As a member of society, the enjoyment of
life each of us has is of benet to society regardless of whether it is shared
with others since society can be thought of as the aggregation of individual
preferences.
In addition, there are costs each of us incurs to protect ourselves or to
reduce potential victimization costs. These costs and the services and goods
acquired to insure oneself against such crimes include life insurance,
medical insurance, alarm systems, pepper spray, and rearms. The degree
to which these are purchased is, at least partially, dependent on the level of
violence against persons in society. If such crimes were reduced, demand
for these services would drop and people would make other choices. Crime
inicts harm on others through an alteration of consumption patterns.

This is known as a negative externality as it causes people to consume
goods and services they would otherwise not wish to purchase rather than
those they originally desired.
Crimes against property represent a purer form of the above since most
of the costs to society entail such negative externalities. Crimes against
property can be thought of as being of two varieties: destructive and redis-
tributive. To the extent that they are destructive (for example, arson), they
represent not only a negative externality imposed on others but also mean
the potential destruction of productive capital and, therefore, can be a bur-
den to everyone, not simply the individual who has her property destroyed.
Redistributive crimes (such as burglary) are less damaging to society but to
the extent they represent the transfer of wealth from those who value it
more highly (the victim) to those who value it less (the burglar), they are
welfare-diminishing. This is based on the economic argument that redis-
tribution ought to encompass the transfer of goods to those who would use
them most productively. If the burglar would have been willing to offer
sufcient payment to the victim to cause the victim to transfer the property
willingly in a marketplace situation, such a robbery is purely redistributive
and is not welfare-diminishing at allindeed, it might be welfare-enhanc-
ing! However, in such a case, in a law-abiding society, the burglar should
have made the transfer in a legal manner instead of via forced transfer.
Regardless if the individual robbery is welfare-enhancing or welfare-
diminishing, the cumulative effect of such redistribution might be the
purchase of additional devices designed to thwart burglaries by society and,
as such, is likely to be welfare-diminishing in the aggregate.
Victimless crimes may also be costly to society to the extent that they
indirectly affect others. Drugs, gambling, and prostitution are often
thought of as victimless because both suppliers and buyers of these com-
modities are willfully engaging in the transaction. This does not mean
harm does not come to one or more of the participants. After all, the only
legal difference between prostitution and legal sexual activity is the
exchange of money. The only legal difference between legal forms of gam-
bling/drug sales and illegal forms is the former are regulated by the state
while the later are not. In addition, these activities may cause losses
to society in general. The drug addict who dies from an overdose, the
VICTIMLESS CRIMES 103
prostitute who acquires AIDS, and the gambler who embezzles to pay off
his gambling debt all may reduce the productive capacity of the nation.
However, the same can also be said of a host of other legal activities. What
tends to separate out illegal activities from legal ones is a moral proscription
against them.
Why Do We Punish Them?

Many people dislike the actions of others even when those actions do not
impede directly on themselves. This dislike may manifest itself only when
these activities are publicly viewable (such as indecent exposure) or it may
be distasteful simply because we know it is occurring even if we cannot see
it (such as bestiality). This dislike may be founded on a genuine worry the
behavior may be a harbinger of increased deviance from societal guidelines
if not arrested early in its manifestation. For example, many psychologists
believe possession and exposure to child pornography, even in illustrated
form, may substantially increase the likelihood of future molestation of
children. However, it often subsists merely on the belief something is
morally objectionable.
For example, homosexuality is viewed by some people as a sin that
must be punished. They see its practice by others as symptomatic of a
decline in moral values and worry that, if left unchecked, it will corrupt
society. In the past, people took a similar view to adultery and interracial
marriage. Yet, adultery, while certainly condemned by many, is no longer
illegal and interracial marriage is now commonplace and quite acceptable
to the vast majority of individuals. At the same time, slavery and inden-
tured servitude were once widely accepted but are both now universally
condemned and are criminally prosecuted. What has happened to cause
these changes?
The answer once again can be derived from economics. If you recall
from Chapter 1, people tend to think at the margin. This means their deci-
sion to engage in a homosexual act is based on a calculation of the added
benet to them of that act and the added cost to them of that same act.
When there are large costs imposed on others who are not parties to a
transaction (called negative externalities), the costs to society of that addi-
tional good may exceed the costs to the individual.
To see this, we can look at a typical argument regarding smoking,

which was once socially acceptable but is increasingly seen in a negative
light. Societys cost schedule is dened by the marginal social cost curve
whereas the private individuals cost schedule is dened by the marginal
private cost curve. We dene the difference between these two costs as the
moral cost (guilt) plus the other associated costs (such as pollution in the
case of smoking) to societys members of certain things being legal.
Societys benet schedule is dened by the marginal social benet and the
private persons benet schedule is dened by the private marginal benet.
Since private individuals do not incorporate the external costs of others
into their decisions, the amount of smoking in society exceeds the socially
optimal amount based on societal preferences (Figure 5.1)
None of this discussion should be taken to imply that societal prefer-
ences ought to be what they are. Certainly, many past crimes of moral
turpitude such as miscegenation and laws proscribing homosexual con-
duct should never have been crimes based on a proper understanding of
freedom. Yet, at the same time, one must question other such crimes that
we currently have in society. The argument against prostitution, gambling,
loan sharking, drugs, incest, and bigamy are no more cogent than the argu-
ment against adultery, which was traditionally a felony (and is still a crime
MSC
MPC
MPB
MSB
Q* Q1
MPB = Marginal Private Benefit Q1 = Amount smoked based on private costs

MSB = Marginal Social Benefit Q* = Socially optimal amount
MPC = Marginal Private Cost
MSC = Marginal Social Cost
Figure 5.1. Private smoking exceeds the socially optimal amount.

in 23 states), but now is almost never prosecuted except in military venues.

Even then, it is only prosecuted by the military under the Manual for
Courts Martial Denition when the conduct of the accused was to the
prejudice of good order and discipline in the armed forces or was of a
nature to bring discredit upon the armed forces.
As the moral cost declines, we would expect to see more such activity.
Indeed, it will also typically result in a lowering of the marginal private cost
curve as well for those individuals who no longer see it as an issue. Thus,
when large segments of the population viewed adultery and homosexuality
as sins, there were correspondingly less such activity (or at least less such
activity visible and open in society). As societys norms have changed and
these activities became more socially acceptable, the distance between the
marginal private cost and the marginal social cost narrowed and the mar-
ginal private cost fell. Thus more individuals today not only see nothing
wrong with adultery but are also more likely to try it because they see
nothing morally objectionable to it.
While there is nothing that can easily be done about the moral objec-
tions except try moral suasion, other costs can impose observable direct
harm on others and need to be mitigated. How do we get an individual
to incorporate those costs into the decision-making process? There are
three basic ways to deal with them from an economics perspective. The
rst is to impose a tax on the activity. The second is to create a market
mechanism. The third is to make the activity illegal.
Taxing and creating a market mechanism are efcient at performing
this task so long as we ignore the element of the population that is irritated
an activity that they consider wrong is still allowed. In such cases, moral-
ity gets in the way of efciency, yet even here, the market mechanism has a
means of striking back by allowing those who are offended to be paid off by
those who are engaging in the behavior.
Let us go back to the 1950s when sodomy was illegal in all 50 states. This
does not mean it does not occur. Suppose two individuals decided to engage
in this act in private and both agreed not to tell anyone about this. What
would be the result? The act would occur, of course! The fact you have a law
prohibiting something is no guarantee it will be enforced. Willing adults
often congregate to stie various legal provisions. If no one within the group
is going to inform on the others, it is unlikely they will be discovered.
What if this action is discovered by someone who nds this behavior

morally reprehensible? Does this mean that the law will be enforced? Not
necessarily. Suppose that the benet to the person engaging in sodomy is
$500, while the moral cost to the discoverer is $300. Can the sodomist strike
a deal with the discoverer to allow sodomy to continue? Yes, it is possible
because the benet to the person engaging in the activity exceeds the cost to the
person who discovers it. The discoverer will proceed to blackmail the sodomist
and both will be the better for the trade (of course, the sodomist would prefer
not to have to pay at all but sodomy is illegal under this scenario).
Suppose that the benet to the sodomist is $300, while the cost to the
discoverer is $500. Can the sodomist strike a deal with the discoverer? No,
because the benet to the sodomist is less than the cost to the discoverer.
As it turns out, these types of transactions occurred quite often with
people blackmailing others for sexual escapades, whether of a homosexual
or adulterous variety. So long as there is a moral stigma or legal prohibition
to the activity, blackmail can be protable. The CIA has not infrequently
engaged in what is known as a honey trap where a beautiful spy seduces
an unwitting foreigner and then blackmails him into betraying his
countrys secrets.
In any case, the evidence is clear: blackmail is a welfare-enhancing
transaction. This is undoubtedly true when the blackmailer has evidence
of criminal activity that she is using against her victim. As noted by
Walter Block1 in his classic book, Defending the Undefendable, blackmail
even can be used to reduce criminal activity. Since the criminal must share
his bounty with his blackmailer, the net benet of criminal activity is
reduced and if the criminal fails to pay up, the probability of apprehension
and eventual conviction is raised since a blackmailer is left without a cred-
ible threat unless she has evidence to back up the claim. Perhaps blackmail
should be the next thing society decriminalizes as it can serve as an effective
tool in the war against other crimes, so long as the blackmailer has not
committed fraud in perpetrating his act in the rst place.
Drugs
We have a failed social policy and it has to be re-evaluated. Otherwise,

were going to bankrupt ourselves. Because we cant incarcerate ourselves out of
this [drug] problem. Retired General Barry R. McCaffrey, director of President

Clintons Ofce of National Drug Control Policy, New York Times, February
28, 2000.
Both incarceration of drug offenders and allowing offenses to continue
have negative externalities. Incarceration costs the government through
direct expenditure on criminal justice as well as via reductions in income
and sales taxation. Individuals in prison have vastly lower productivity not
only while in prison but also suffer from skills degradation, so lower pro-
ductivity persists even after release.
Freeman2 developed what is known as the Freeman Parameter to
quantify the lost productivity resulting from the removal of otherwise pro-
ductive workers from the workforce. His results for the nation in
1993 closely align with those of California in 2001: for every 16 men in
the workforce, there is 1 man who is under the watch of the criminal
justice system. The result is a drain of about 5% of GDP from lost pro-
ductivity.3 Of even greater concern is the movement of children onto the
welfare rolls due to incarceration of absentee fathers who are unable to
meet their support obligations. This can perpetuate a life cycle of criminal-
ity since individuals with such histories typically have a higher likelihood of
criminal tendencies in adulthood. What is really not of concern from the
standpoint of economics is that these individuals have moved onto the
welfare rolls in the rst place. Increased welfare payments to such children
(who were not working to begin with) simply represent a transfer of wealth
from working individuals to non-working individuals. Whereas before that
transfer of wealth went from an individual who is now incarcerated, it now
comes from the society at large. Yet to count this as a cost of the drug war
would be double counting the effect because we have already accounted for
the loss to society through the removal of the productive individual from
the labor force. Certainly it means higher taxes but unless we can show that
a dollar spent by the individual who is taxed benets them more than the
benet received by the child who receives a welfare dollar, we cannot make
a judgment as to whether the transfer payment is to the benet or detri-
ment of society.
Incarceration, to the extent drugs are prohibited not only from a legal
standpoint but from a practical one, can provide drug addicts with the
opportunity to kick the habit and detoxify themselves. Assistance toward
this provided in prison can aid in the recovery of such individuals and
lower death rates by drug-related causes will result. It is unclear whether
there will be much of a reduction in crime by locking up drug offenders.
While some offenders commit violent crimes due to pharmacological
effects of drugs and others will engage in prostitution and theft to enable
them to pay for their habits, the vast majority of drug users engage in this
use without ancillary criminal behavior. A large percentage of the working
age population habitually (at least once a month) consumes illegal drugs
(mostly marijuana) and an even greater percentage abuses prescription
drugs. Even so, chances of being caught for any drug offense are remote.
Stricter sentencing is unlikely to bring about dramatic reductions in crim-
inal activity for this segment of the population. This is because it is the
certitude of punishment as opposed to the severity that causes the greatest
reductions in such behavior. With a small chance of getting caught and
with many of those offenses being misdemeanors, there is little reasons to
reduce consumption. More concern seems to be with the supply side as
opposed to demand side, which is precisely the wrong way to win the drug
war.
There are other costs associated with the drug war as well including
breakdowns of the family unit and moral costs associated with both the
visible aspects of the problem and the knowledge that certain individuals
are engaging in these activities. In addition, there is increased corruption.
The very illegality of drugs has also made it very protable and much of
these prots can be used to assist in bribery of law enforcement and other
public ofcials. Such incidents make the criminal justice system inherently
less efcient and fair and thus have detrimental effects that go well beyond
the corrupt act itself.
To fully understand the drug issue, it is best to build a supply and
demand model. We have two groups of individuals, addicts and occasional
users, who comprise the demand for the drug. On the other side of the
issue we have the dealers. Many studies seem to suggest addicts have a
perfectly inelastic demand for drugs, while occasional users will be price
sensitive. I agree occasional users will be more price sensitive than addicts
but disagree with the assumption of perfectly inelastic demand for
addicts as will be demonstrated shortly. However, for now, we will assume
addicts disregard price. They have a need and they will fulll it regardless of
the cost. Still, even under these assumptions, in the long run, the impact of
price on addicts will become less than perfectly inelastic as some occasional
users (who are price sensitive) will shift into the realm of addicts due to
overexposure to the drug, thus attening the addicts demand curve. The
various demand curves for both addicts and occasional users in both the
short and long runs are given in Figure 5.2. You will notice that even occa-
sional users have more elastic demand curves in the long-run. This is
because if prices stay high, they will tend to shift to other drugs or activities
that substitute for drug use. The reason for the high inelasticity for addicts
is precisely since there is no substitute for the high they receive from the
drug while occasional users by their very actions show other activities or
drugs are substitutes. They are more sensitive to price changes than are
addicts.
Individual addicts develop tolerance for the drug (Figure 5.3), causing
an outward shift. Overdose deaths cause subsequent reductions, so the
long-term trend is uncertain.
Overall demand for the drug depends on the relative distribution of
addicts and occasional users in a market. The greater the percentage of
addicts, the more inelastic the demand curve. It might also be the case
the addict market is not perfectly inelastic in the short-run, but instead
Short-run Addicts Occasional users

Price
Price
Long-run Quantity Quantity

Price
Price
Quantity Quantity
Figure 5.2. Demand for illicit drugs by addicts and occasional users.
displays a more elastic trend similar to the long-run, if addicts run up

against wealth constraints that limit their ability to procure drugs.
Addicts represent the greatest cost to society. With their dependency
on a drug being so great, they are less productive, more likely to engage in
ancillary criminal activity, and more likely to be caught and prosecuted
than the occasional user who consumes an ounce or two of some illegal
narcotic.
Market reaction depends on whether it is monopolized by organized
crime (such as the crack cocaine market) or if it is a perfectly competitive
market (such as marijuana). The monopolized market will be characterized
by lower output and higher prices than the perfectly competitive one in the
short run as well as a deadweight loss represented by the loss due to extrac-
tion of monopoly rents (Figure 5.4). As addicts are more likely to pay the
Addicts
Price
Quantity
Figure 5.3. Drug tolerance drives increased demand by addicts.
Monopolization by Perfectly competitive market

organized crime MC
S
PM Deadweight loss
Price
Price
PC
D
MR D
QM QC Quantity
Quantity
Figure 5.4. Comparing a monopoly market to a perfectly competitive

one.
higher prices in the monopolized market, we would expect markets inl-

trated by organized crime to have a higher percentage of addicts than
perfectly competitive ones. That is not due to an increase in the number of
addicts but because of a decrease in the number of occasional users unwilling
to pay monopoly charges of the crime syndicate.
Organized crime could try to engage in third degree price discrimina-
tion. Addicts will pay higher prices and occasional users lower ones. No
such opportunity exists in the perfectly competitive market where everyone
pays the same price. The presence of price discrimination increases the
quantity sold as well as overall revenues but overall sales will still be less
than under perfectly competition (Figure 5.5).
The one exception is if the criminal enterprise can engage in rst-degree
price discrimination (Figure 5.6) in which the individuals willingness to
PA
MC
MC
D
MR=MC
MR D MR
Addicts (on the left) pay more than occasional users (on the right)
Figure 5.5. Third-degree price discrimination.
Monopoly with first-degree Perfectly competitive market

price discrimination
S S
Consumer
surplus
Price
Price
D D
Quantity Quantity
Revenues for the Firm
Figure 5.6. First-degree price discrimination.

pay is the actual amount they pay for the drug. There will be no reduction
in quantity for the monopolist versus the perfectly competitive market but
the monopolizing rm will have a lot more revenue as every individual
consumer will be paying a different price all the way down to the perfectly
competitive price. The amount of income that the drug users in the per-
fectly competitive market will retain will be much lower, while prots for
the monopoly criminal rm will be far higher, providing additional
resources for corruption and maintenance of the criminal monopoly.
Given these facts, we need to understand what happens when we
undertake efforts to reduce drug use. Concentrating on the supply side
only pushes up the price of the drug (from P1 to P2), deterring occasional
use but doing little to control addiction as shown in Figure 5.7. Since most
of the losses associated with drugs are fostered by addicts, drug interdiction
efforts will likely be of little benet in reducing ancillary costs.
Increased prices for addicts leads to more criminal behavior. This is an
issue when organized crime engages in price discrimination. Higher prices
paid by addicts lead to more crime in other areas as addicts seek to pay for
their habits. It allows for expansion of control by organized crime into
other markets, such as prostitution, which is covered in the next section.
Public policy designed to reduce crime might seek reversal of price discrim-
ination policies undertaken by the organized criminal enterprise: force
higher prices on occasional users to deter use and lower prices for addicts.
This can be accomplished by increased enforcement efforts against occa-
sional customers as well as the provision of addict cards that allow addicts
S2 S2
S1
S1
P2
Price
P1
Addicts Occasional users
Figure 5.7. Attempting supply-side interventions to reduce drug use.

to acquire drugs at reduced cost in regulated markets. This is public policy

in the Netherlands and some parts of Canada.
With a perfectly competitive market, what about enforcement on the
demand side? This will reduce the price of drugs, which would be a good
thing for drug addicts, who would no longer feel the need to commit ancil-
lary crimes to support their habits. To be effective, however, one would
have to concentrate on the occasional users, who are harder to identify and
capture. Policies that go after addicts would similarly reduce demand but
likely will only do so during the period of incarceration. The success of
such a program long-term would depend on the ability of correctional
ofcers to keep drugs out of the hands of the addicted prisoners. Unfortu-
nately, prison is notoriously a place where drug addiction actually increases
as opposed to getting alleviated. In addition, the reduction in price over
time might lead to expectations of lower prices and the consequent increase
in demand by occasional users to ll in some of the void.
There are other possible avenues to reduce drug dependency. Medical
intervention, such as methadone maintenance therapy, which substitutes
methadone for heroin or other opiates, can be tried. This does not work
with drugs that are not opium-derived, such as cocaine. This type of treat-
ment is dispensed orally under controlled circumstances to reduce the
effects of craving of opiates without causing euphoria. In more recent tests
in Switzerland, controlled heroin injections were found to be more effec-
tive in reducing dependency. The amount is slowly reduced to ease with-
drawal pains. Similar programs are now under way in Canada, Australia,
Germany, Spain, and The Netherlands.
We can also maintain dependency within a legally regulated environ-
ment. Britain dispenses drugs such as pure cocaine and heroin through its
National Health Service to known addicts with a prescription that does not
cost the patient anything and costs the British government very little. The
drugs are purer and addicts are given syringes so they not share needles.
This reduces the death rate from taking drugs.
However, there are drawbacks. Since drugs are dispensed legally to
those proven to be addicts but remain illegal for others, there are oppor-
tunities for arbitrage. Unless drugs are dispensed in a controlled environ-
ment, addicts can go clean and then sell drugs on the open market at
incredible markups. Yet if there is monitoring of the actual injection or
ingesting of the drug, many individuals may feel uncomfortable and may
not wish to participate, thus lowering potential benets. There are also
moral costs associated with dispensation of drugs. Additionally, the lower
demand for the drug would normally reduce price unless enforcement
efforts against occasional users are increased simultaneously. These actions
will make arbitrage all the more protable. Thus the government could be
subsidizing the very industry it is seeking to stamp out.
A nal possibility is complete legalization. Such a program would dra-
matically reduce cost for suppliers and will fuel demand due to reduced
stigma and penalties attached to drug use. The effect on the price of drugs
in indeterminate and depends on whether the decrease in costs or the
increase in demand dominates. Decriminalization is currently public policy
for personal use in several countries. However, decriminalization is not the
same as legalization. It is instead a refusal to prosecute users and shifts the
focus to supply management techniques. However, supply management
doesnt work. Legalization would make both sides exempt from criminal
sanctions. Taxes can be put in place to pay for negative externalities. The
impact of taxes either on the seller or the buyer would have an effect similar
to the outright prohibition we have currently imposed, except that the
current penalty is probabilistic in nature: you may or may not go to jail
or prison for your actions while a tax is uniformly imposed. Of course, even
now, each addict has opportunity costs associated with trying not to get
caught. These opportunity and transaction costs would dissipate in a legal-
ized framework.
Legalization will cause an increase in both supply and demand and
could also lead to concentration within the industry as smaller players con-
solidate and grow. There are likely signicant exploitable scale economies.
There could be increased competition due to reduction of barriers to entry
and elimination of the effects of law enforcement. There will likely be
reductions in corruption and law enforcement costs as well.
Prostitution
Prostitution is a somewhat complicated matter with respect to if it is truly
victimless. To the extent it is a choice, no matter how reprehensible that
choice may be to others in society, the prostitute cannot be construed to be
a victim. Yet when children are the prostitutes or the prostitute is a drug
user or an illegal alien placed in a type of servitude to pay for drugs or the
service of transporting to a new land, the prostitutes are victims. Similarly,
individuals set into prostitution by human trafckers are victims. Yet those
in legal brothels throughout the world, and women who are self-employed
as prostitutes make prostitution a career choice and are not victims in the
classic sense of the word.
The exchange of sex for money is the dening characteristic of prosti-
tution for most people but, in truth, it is the contractual obligation to
satisfy the sex contract that qualies a particular action as prostitution.
Sex in adult lms is a form of prostitution even if such arrangements are
typically legal under the clause the payment is for acting services as opposed
to sex. Similarly, despite some feminist protests to the contrary, the mar-
riage contract and dating that results in sex are not forms of prostitution
because there is no contractual guarantee of sex in either case, even if there
is a large amount of money being spent and a strong desire on the part of
one of the parties to engage in sexual relations.
Prostitution is illegal in all states except for Nevada where it is legal
everywhere except in Clark County (where Las Vegas is located), Washoe
County (where Reno is located), Douglas County (where Lake Tahoe is),
and Lincoln Counties, as well as the capital city of Carson City, which is
not part of any county. It was completely legalized in the Netherlands in
2000, although prostitution itself had been legal since 1810, from 1911 to
2000, it had to be conducted outside of brothels, which were illegal during
that period. Other countries have interesting ways to control prostitution.
In Sweden, it is legal to be a prostitute but not a customer, which means
the Swedes employ a demand restraint system only (Figure 5.8); the result
is a lower price and reduced prostitution.
Cracking down on prostitutes decrease the quantity of prostitution and
increases its price (Figure 5.9).
Prostitution is somewhat different from illicit drugs in that there may
be an ability to alter the market through manipulation of legal markets for
goods and services. Many people believe in a linkage between pornography
and prostitution. If pornography degrades women and increases sexual
desires, an increase in pornography may increase demand for prostitution,
driving up its price and quantity. Thus taxation of pornography may have
P1
P2
D2 D1
Q2 Q1
Figure 5.8. Demand restraint to reduce prostitution.
S2
S1
P2
P1
D
Q2 Q1
Figure 5.9. Going after the prostitutes.
an indirect effect of reducing prostitution. This would not be the case if

pornography serves as a substitute for prostitution. In that case, one might
want to increase pornography in order to reduce prostitution. The issue of
whether these are complementary or substitute goods cannot be settled
theoretically but can only be determined through empirical research.
Making it illegal to rent a room by the hour would drive up costs and
thus cause a reduction in prostitution. Reductions in discrimination
against women in employment and increased pay for occupations tradi-
tionally served by women will reduce prostitution by increasing the oppor-
tunity cost.
One aspect of public policy often not discussed is the impact on human
trafcking. Actions that concentrate on the prostitutes have the impact of
increasing the price of the service and thus could contribute to increases in
human trafcking since it raises the effective price that trafckers can
receive.
For the Economist: Segmented Labor Markets

Despite calls that crackdowns on illegal or undocumented migration are
racist, actual laws regulating immigration are eminently devoid of racial
overtones. Still, sentiment supporting such laws is racial and congeals over
the visible impact of day laborers.
Day laborers work in the informal economy, a shadow economy that
mirrors many jobs of the formal legal sector but which has a lack of
enforcement mechanisms typied by the legal sector. It develops sponta-
neously based on a perceived need and may exceed the size of the legal
sector in third world countries. In the United States, it is usually charac-
terized as coming out of a desire for tax evasion or engagement in illicit
activities, although these are more myth than reality. Yet, it often exists as a
mechanism to allow unbridled capitalism where stiing government regu-
lation chocks off entrepreneurship.
In the United States, the informal sector is typied by day laborers and
agricultural workers. It is also the last refuge of the American garment
manufacturing industry. Unlike highly skilled legal immigrants, illegal
immigrants utilize the informal sector to allow them to work in areas where
they have experience in their home countries. The transitory and contin-
gent nature of their work means they are paid in cash and exist in a quasi-
legal environment where they can congregate freely and openly at known
locations even though their employment without proper working papers is
against the law.
Day laborers evade regulations by working as independent contractors
on a daily basis and since they often move between employers each day, the
employer is usually not obliged to report the payment for purposes of social
security or income taxation. Instead of workers seeking employment
through want ads, employers seek workers by showing up at day laborer
pickup locations. Informal worker ability to perform simple household
repairs or improvements in exchange for cash payment with few questions
asked is a convenient and low-cost option for homeowners who otherwise
must pay far more to a contractor. The market is one in which those with a
legal right to work in this country compete openly and on equal footing
with those who have no such right. This is in sharp contrast to the formal
market where concerns over proper documentation have limited illegal
alien employment. Documented workers are more certain of their rights
to a legal claim that can be exacted in small claims court for non-payment
and this may lead to greater employment opportunities for illegal workers
who are unsure of their rights in such matters and do not wish to risk
deportation.
This is a case of segmented labor markets where markets are distinct with
different participants but they are also interdependent We dene the for-
mal sector as having two markets: a skilled and an unskilled market for
labor. The skilled market is characterized by production complementary
to the unskilled market. Increase in output of the skilled market pushes
up demand for the unskilled market and vice versa. The informal market
is exclusively unskilled and is a substitute for the formal unskilled market.
The supply of labor will be fairly inelastic in both markets of the formal
economy but highly elastic in the informal market (Figure 5.10). For all prac-
tical purposes, the supply of labor is innite in countries that send migrants,
meaning deviation from perfectly elastic supply of labor is due to immigra-
tion restrictions. The more restrictions placed in terms of legal impediments
and immigration enforcement, the less elastic the supply. If there were no cost
to move, the informal sector would have perfectly elastic supply.
Instead of using the term price, we use the term wage on the graphs.
The wage rate paid is the price of labor. Increases in output from the skilled
Formal sector Informal sector
S*
Wage
Wage
Quantity Quantity
The formal sector is characterized by a fairly An increase in enforcement action against undocumented
inelastic labor supply function aliens will result in a more inelastic labor supply due to higher
costs to cross borders.
Figure 5.10. Segmented labor markets.

labor market will increase demand for labor in the unskilled labor market.
If the unskilled labor market does not have to compete with the informal
sector, wage rates will rise more rapidly in that sector. Since the output
from the unskilled sector is a function of the number of workers and the
price in the informal sector is lower, increasing output in the informal sec-
tor will increase wages faster in the skilled sector than if output increases in
the unskilled formal sector (Figure 5.11).
When we combine the two markets in Figure 5.12, we can see the
impact of lax law enforcement for immigration violations on wage rates for
both illegal aliens and unskilled natives.
Illegal immigration pulls down wages of unskilled worker who compete
directly with illegal aliens and wages of illegal aliens themselves, while
W2 S
W2
W1 W1
D2
D2
D1 D1
L 1 L2 L1 L2
The more inelastic the supply of labor, the more increases in demand will cause increases in the wage rate
Figure 5.11. Effect of increased demand on wages.
SL
SL + Sl1
Wage rate
W1 SL + Sl2
W2
L2 L1 L1 + l1 L2 + l2
Labor employed
When immigration enforcement becomes more lax, the wage rate falls for both unskilled in
the formal market and in the informal market. However, employment FALLS in the unskilled
formal market but RISES in the informal market, which is composed of illegal aliens.
Figure 5.12. Effect of lax law enforcement.

increasing wages of skilled laborers. Making unskilled labor subject to the

same requirements as skilled labor to enter the country (i.e., through a
points system) would make the supply of labor more inelastic and would
raise wages. Since the wage bill is lowered, this could result in a lowering of
costs that would partially compensate individuals for their lower wages.
If productivity could be enhanced through this process, the net result can
be benecial for all except those formal sector unskilled workers who lose
their jobs (L1 L2). In any case, illegal immigration makes formal skilled
workers better off, raising wages by more than legal immigrants, who tend
to compete with those same skilled workers.

1. If immigration ofcials launch periodic sweeps of sweatshops and
other hiring areas for undocumented workers, what will happen to
the wages of those undocumented workers who are not caught?
Wages for those illegal aliens who are not caught in such sweeps will
rise because the labor supply curve will become steeper.
2. If abortions are made illegal, what will happen to the market for
prostitution?
Making abortions illegal will raise the opportunity cost for the prostitute
and thus will lead to higher prices and a lower supply.

1. Apply the segmented market model to the market for counterfeit
goods. If counterfeit goods are allowed to exist, what will happen to
wages for those workers who produce genuine goods?
2. How might a needle exchange program (where the government or a
non-prot freely exchanges new syringes for old syringes) affect the
market for drugs as well as the overall economy?
CHAPTER 6
Crimes Against Property

Property rights are at the heart of the capitalist system and our democracy.
Without ownership of our property, there can be no freedom. We would be
stuck trying to protect what we perceive as ours through use of force at all
times and thus we would be unable to progress as a society. Children very
early on generally understand the concept of mine, although the concept of
yours does tend to take a little longer to develop. We all feel violated when
someone invades our personal space or takes our property without permis-
sion. Indeed, if you think about how we relate to others as individuals, com-
munities, and societies, in every case, the concept of what is mine and what
is yours dominates. Armies and government security forces exist to control
land and property that is considered the sovereign domain of a nation.
Companies create products and guard their physical and intellectual property
with zeal. Individuals seek to acquire goods and services that they personally
own. Without ownership, life and liberty would be at stake since we would
be unable to secure shelter, food, or water to survive. Indeed, it would not be
farfetched to state that crimes against property constitute the single greatest
threat to our freedom and security. In this chapter, we will explore various
threats to property and how economics can be used to deal with them.
Torts
As discussed in the previous chapter, there have been evolving standards
over what constitutes a crime. Not all wrongful acts are crimes. Simply
because someone has done you wrong, it isnt necessarily a crime. Some are
purely moral crimes over which one can legally do nothing. An example of
this is the crime of plagiarism, which is one of the venial sins of academia,
unless it rises to the level of copyright violation. Plagiarism is dened in
academia as the taking of someone elses idea and either representing that
idea as ones own or using it without giving proper reference. Even if the
words are not taken but the thoughts expressed are such that they are
unoriginal with the author but were instead deliberately lifted from some-
one else and falsely represented as being original with the author, plagiarism
has occurred. Yet it is something that cannot be prosecuted in most cases.
Of course, it is a matter of degree. The mere taking of an idea from someone
else may constitute plagiarism but unless the idea was patented, such takings
may be legally permitted, even if the act is morally reprehensible. An excep-
tion is made in certain creative industries. Movie treatments, for example,
have been found to have greater legal grounds for a lawsuit than would nor-
mally be found in common law. Thus the submission of a movie idea that
proves substantially similar to a produced movie may engender a successful
tort action if it can be proven that the idea provided the genesis for the nal
script. Still, while the specic expression of that idea may be protected by
copyright, unless there is material gain, it is unlikely that one can prove
criminal liability, although civil liability may emerge.
A tort, which is a wrongly committed act against another that can be
pursued through a civil process, is more encompassing than criminal action.
Torts are not contractual violations, but are instead violations of law, but
they do not rise to the level of infraction (the lowest level of criminal offense).
They are, in the broadest sense, violations of specic rights and obligations
that are legally acquired and these violations can be remedied via a court
process. I cover torts in much more detail in my forthcoming companion
book from Business Expert Press entitled Economics of Common and Civil
Law. but for now on some differences between crimes and torts.
Theft is not a tort. Torts are violations of a set of rights associated with
property; they are not violations of property. They are associated with
interference with legitimate rights of others, not prevention of exercising
rights implicit when one actually takes property through theft. Torts also
involve accidental damage caused by one person without having to dem-
onstrate negligence or intent.
A tort can be brought for intentional or negligent damage caused by
another either to property or to a person, even if the individual who com-
mitted the tort has been acquitted in a criminal trial. This is because crim-
inal law, for the most part, does not provide for civil liability wherein the
individual causing the damage is liable to pay damages to the victim.
Although restitution may be made as part of a criminal complaint, it is the
duty of the criminal justice system to seek redress and recompense to
CRIMES AGAINST PROPERTY 123
society in general, not the victim. A murder not only harms an individual
family but it also harms society (although the harm to the individual and
his immediate family is no doubt far greater on a personal and nancial
level than the effect on other individuals). Criminal processes can only
adjudicate whether someone is guilty beyond a reasonable doubt (rather
than declared innocent) of a crime. Torts adjudicate whether someone is
responsible for an action causing harm, based on preponderance of the
evidence, a lower standard than the beyond a reasonable doubt required
for a criminal complaint. These differences mean that even when a person
is found not guilty of a crime, a civil case can still be brought by the
aggrieved party. An example is the civil judgment against O. J. Simpson
where he was found liable for the deaths of Nicole Brown Simpson and
Ronald Goldman even as he was acquitted of murder in a separate trial.
Theft
Theft is a transfer of wealth from one individual to another that is both
unauthorized by government and unsanctioned by the individual for
whom the wealth is pilfered. From the standpoint of economic efciency,
it is no different than when the government taxes Peter to pay Paul, yet we
accept taxation (for the most part) as legitimate and theft as wrong, even if
we dont agree that the government should be taking money from one per-
son to pay another. When government taxes and redistributes income
without direct consent, it may be a legitimate use of power but when a
private individual does it, it is illegitimate. Part of the reason is, in a democ-
racy, the governments actions are, to at least some extent, controlled by
the electorate. Since governments are elected, we can think of its actions as
have the indirect consent of the governed, even if direct consent is not
given. Governments also adhere to the rule of law. If the government
behaves in a capricious manner with regard to taxation, we can sue and it
will (usually) obey the judgment of such courts. However, thieves are an
entirely different group altogether. They steal at random (from the perspec-
tive of the victim) and their form of redistribution is not taking from those
who have and giving to those who have not but instead is taking to enrich
themselves. Indeed, most of the time the individual being stolen from is
not wealthy by any stretch of the imagination.
If it were simply a matter of redistributing wealth from one individual to

another, economics could not answer by itself whether it was good or bad for
society: for while the victim is worse off, the perpetrator is better off and the
economic calculus suggests actions that improve the life of one person while
worsening the life of another may still be efcient provided the betterment
outweighs the loss: the family that is starving that steals bread from the
wealthy is one example. However, since we cannot compare utility on an
interpersonal basis, it might very well be we produce greater unhappiness in
the glutton who cannot partake of a third slice of cake than we produce
happiness in the individual who will now not starve to death. The irony is
in refusing to make a moral distinction, economists makes moral distinc-
tions: we act as Inspector Javert did to Jean Valjean in Victor Hugos Les
Miserablesthe theft of bread even to save anothers life may not be a mor-
ally acceptable standard because we may be causing more harm than good,
an assertion that would be comical if it were not so serious.
More to the point though is property crimes do cost society in general,
not because of the involuntary transfer that occurs, but rather because they
generate demand for essentially unproductive goods and services: burglar
alarms and the like, none of which would be on anyones list of desirable
objects if theft were not a concern.
The key to understanding property crime is to understand that thieves
are attracted to two things: expensive property (preferably that is easy to
transport or carry, does not require documentation as to ownership upon
transfer, and can easily be converted into cash) and lax security. Yet of these
two, the latter is probably more important. The number of cars that are
stolen because someone left his keys in the ignition is numerous. Similarly,
leaving ones door unlocked or, even worse, opened can only lead to trou-
ble. Yet simple things can be done to reduce the incidence of theft dramat-
ically. Most important though, the security must be visible to be of use.
While invisible security may reduce successful break-ins, it will attracts
attempts and the more the number of attempts, all other things remaining
the same, the greater the likelihood of success.
In the movie, Dr. Strangelove or: How I Learned to Stop Worrying and
Love the Bomb, the Russians quickly realize that the arms race has made
their job of keeping up with the Americans incredibly expensive and
equally useless. Instead of trying to do so, they devise a simple but effective
strategy to forestall the nuclear threat: they build a doomsday device which
is set to automatically deliver a thermonuclear response of their entire arse-
nal if even one bomb is dropped on them. In so doing, they hope to pre-
vent war: what entity would go to war if the other side had a credible threat
to essentially commit suicide and take the other side with them? Only one
problem: they neglect to tell the Americans they have developed this.
When a mad colonel decides to launch a nuclear air strike on the Russians.
Well, I dont want to spoil the movie ending for you.
Thus it doesnt matter what your security system is if thieves are
unaware of it. Professional thieves can disable many such systems, even if
it does take extra time and once they have committed to a job, the marginal
cost of completing it goes down. They are more likely to complete the job
they have already started. If you warn the thief you have a system even if you
do not, you reduce the incidence of break-ins from the outset.
Jamaica, for example, despite a high murder rate, has a fairly low prop-
erty crime rate because most home owners have armed security guards who
respond quickly to alarms going off. A mistake can trigger a response unit
with automatic weapons and the concrete-walled homes also typically have
burglar bars on their windows and doors, all of which make breaking into
the home more difcult than in the United States, where homes have
numerous glass windows and fewer homes are protected by alarms.
Involuntary transfers of wealth have other consequences as well.
Greater feelings of insecurity and less well-being result from burglaries in
an area. Such transfers weaken the institutions of private property. Since
stolen property remains the property of the original owner, even if one
purchases a good, it can be conscated and given back to the individual
from whom it was stolen. This is, of course, another good reason to beware
of people selling televisions outside of a moving van at the corner of 35th
and Broadway for 20% of the price in the store, no warranty or box
offered, cash on delivery expected.
Supply-Side Changes
There are certain discernible effects on society in general from such crimes,
even if we are not personally victimized by them. Additional resources put
in to protect merchandise from being stolen, security guards and alarm
systems designed to keep burglars at bay, insurance to allow for the recov-
ery of losses if they occur, all end up costing money. Even if a business does
none of these things, it will need to self-insure by generating greater
revenue to replace losses should they occur. This will have the effect of
increasing the cost of doing business, thus raising the supply curve
(Figure 6.1).
This also reduces the quantity sold (from Q1 to Q2) and raises the price
paid (from P1 to P2). These higher costs will not be fully paid by the con-
sumer, although the business will be able to pass some of them on to its
clients. The reduction in business as a result of these higher costs leads to a
reduction in quantity, which implies all costs cannot be fully passed on in
the form of higher prices.
To understand what proportion of costs is passed on and what propor-
tion must be absorbed by the business, we need to understand how the
supply curve shifts. Since the supply curve represents the marginal cost of
selling an additional unit, it shifts upward by the extra cost encountered by
the business. Thus, as seen in Figure 6.2, this increase in cost is greater than
the increase in price the consumer must pay. Part of the cost of theft is paid
by the business because it cannot fully recoup its costs and retain the same
level of sales. This will lead to job loss within the business sector experienc-
ing the theft and can become a vicious cycle as higher prices lead to more
theft. An alternative way of thinking about it is to think the consumer pay
higher prices but the business loses sales.
S2
S1
P2
P1
D
Q2 Q1
Figure 6.1. Effect of property crime on business costs.

S2
S1
Paid by business
Increase P2
in cost Paid by consumers
P1
D
Q2 Q1
Figure 6.2. Who pays for theft?
The degree to which this will be reected in higher prices or lower sales
is based on the price elasticity of demand, which is dened as the percent-
age change in quantity demanded divided by the percentage change in
price:
(6.1)
This number will lie somewhere between 0 and . That is because

the demand curve, except in the extreme cases of a vertical or horizontal
demand curve, slopes downward. People demand more as price falls, not as
price rises.
However, what happens when demand is horizontal, when one can sell
all that one wants at a certain price but nothing above that price? This is
what is known as a perfectly competitive market, one in which there is
perfect information, no transaction costs, numerous buyers and sellers, and
a completely homogeneous good. In such a fairy tale world, no one could
sell for above the market price because one could always get that market
price from some other seller. Similarly, no one would price below the mar-
ket price because it would not be protable to do so since the endeavor
would not cover costs. Under such conditions, competition would drive
prots to that level that only covered the rms opportunity costs (includ-
ing a normal accounting prot) and rms can sell all they want at the price
prevailing in the market. In such a case, increases in costs at the individual

rm level that are not reected in increases in costs for all sellers in the
marketplace are paid by the sellers as the increase in price cannot be passed
on to the buyers. Firms can still sell all that they want at the price that
prevails in the market but they now wish to sell less due to the increase in
costs imposed by theft (Figure 6.3).
This is not the case for the perfectly competitive industry which experi-
ences a general rise in the cost structure for all market suppliers (Figure 6.4).
In that case, the consumer pays the full cost of theft but the business
receives fewer sales. This is because the price established by the market rises
by the full cost of the theft.
S2 S1
Q2 Q1
Figure 6.3. The business pays for theft in perfect competition.
S2 S2
S1
S1
P2 D2
P1 D1
Industry Firm
Figure 6.4. When theft raises cost across the industry, the consumer pays.
D
S2
S1
P2
P1
Figure 6.5. Perfectly inelastic demand means the consumer pays.
With perfectly inelastic demand, there is no reduction in output and

the price fully reects the cost of the increase in theft. This can only occur
at the industry level. Individual rms cannot face inelastic demand since, if
they did, they would raise prices to generate more prot. Thus, salt may
have inelastic demand (salt has few substitutes) but Mortons salt (the salt
container that has the drawing of the little girl holding an umbrella on it) is
easily swapped for a generic brand.
Situations where the demand curve is negatively sloped will be between
these two extremes and the cost of theft will be split between buyers and
sellers of the commodity. If the demand curve is more inelastic or vertical
in orientation, buyers will be the principal payers of the cost of theft pre-
vention and good recovery. If it is more elastic or horizontal in orientation,
the sellers will be the principal payers of the cost. If the rm attempts to
raise price to recoup losses, it will see a loss in quantity sold that will at least
partially cancel out its gains in revenue due to price appreciation and, if the
theft is one exclusive to that rm, leaving the rest of the industry intact,
revenue losses from quantity reduction will exceed revenue gains from
price appreciation.
Demand-Side Changes
Increases in burglaries affect demand for insurance and demand for prop-
erty. An increase in burglaries also leads to increased costs for insurance
companies through payouts for losses. This results in an upward shift of
the supply curve. The rise in demand for insurance tends to push up the
price of insurance and increase quantity sold, while the upward shift of the
supply curve will also push up the price of insurance but decrease quantity
sold. The effect on the quantity of insurance sold is indeterminate and
dependent on whether the demand-side effect or the supply-side effect
dominates. There will be an unambiguous rise in the cost of insurance
(Figure 6.6).
The price rise of insurance will cause a drop in demand for insurable
property because these two are complementary products. Thus, for exam-
ple, expensive jewelry will be affected and jewelers will face both reduced
sales and lower prices for their products. In addition, demand for such
goods will likely drop in the aftermath of burglaries, even if insurance could
never have be purchased at all on those goods, because of worries over the
potential loss of the item through theft (Figure 6.7).
S2
P2
P2
P1 P1
D2
D2
D1 D1
Q2 Q1 Q1 Q2
In this case the quantity of insurance sold falls In this case the quantity of insurance rises
while the price of insurance rises while the price of the insurance rises
Figure 6.6. Effect on property insurance market of increase in number

of burglaries.
P1
P2
D2 D1
Q2 Q1
Figure 6.7. Effect of insurance price increase on insurable property

demand.
The degree to which decreases in demand will be reected in lower

prices or lower sales is based on the price elasticity of supply, which is
dened as the percentage change in quantity supplied divided by the per-
centage change in price:
(6.2)
This number will lie somewhere between 0 and . That is because the
supply curve, except in the extreme cases of a vertical or horizontal demand
curve, slopes downward. Firms supply more as price rises, not as price falls.
Perfectly elastic supply occurs in the case of free, non-market goods, such
as air, which, for all practical purposes, is unlimited and without opportunity
cost (though clean air may be quite limited and cost-prohibitive in many
urban environments, especially in the Third World). In such a case, price
will not rise above zero even for vast increases in demand. An example are
songs illegally downloaded from the Internet. Such situations are unlikely to
last forever and, at some point, price will rise to a non-zero amount.
What happens to home prices when crime rises in a neighborhood?
Home prices decline because fewer people want to live there. We see this
using supply and demand graphs by representing the supply of housing as a
stock, which is xed for the short-term, and varying demand (Figure 6.8).
Similarly, when forgeries are commonplace, the price of originals
declines due to reductions in demand for artwork. This reduction in
demand arises due to uncertainty over whether a particular painting is by
a master artist.
P1
P2
D1
D2
S
Figure 6.8. Effect on area home prices of rise in burglaries.

Fenced Goods
Any increase in the rate of theft almost always represents an increase in the
supply of stolen property to fences, individuals who sell stolen property to
others. The only exception is when the thief procures goods for himself,
such as weapons, drugs, or cash.
Fences provide cash conversion of such property to the perpetrators of
burglaries. Rarely do fences provide anything close to full value of the
goods. They operate in the grey areas of the legal arena, purchasing prop-
erty without asking about ownership, and taking goods from both legit-
imate and illegitimate trafckers in property. Since a lot of property lacks
documentation as to its ownership upon sale, it can be dispensed not just
to those who know the good is stolen but also to legal businesses, such as
pawn shops, at the prevailing rate for legally acquired goods. Goods
that are high in value but low in documentation often attract thieves.
A Picasso will often go to a client who has commissioned its theft. Thefts
of rare coins or unique pieces of jewelry will be similarly difcult to
unload. Other goods, such as microchips, are handled in bulk by indi-
vidual agents who just happen to have a few hundred of the latest
AMD or Intel processors.
At the same time, some goods must be reprocessed before being sold
again. Cars with their vehicle identication numbers are difcult to resell
in whole and are taken either to chop shops to break them into various
parts that can be sold to repair shops or are shipped out of the country to
resume their life abroad. There are far more cars on the roads of the Third
World than were acquired through completely legitimate means. Aftermar-
ket goods that have been reprocessed often meet demand from the legiti-
mate market and are difcult to discern from other goods.
Demand in the stolen goods market shifts due to changes in demand
for the underlying good or, when individuals know the good is stolen,
because of changes in morality or laws concerning possession and receipt
of stolen property. Thus, if you increase penalties for those who ultimately
purchase stolen property, you not only reduce the quantity of stolen prop-
erty but also reduce the number of burglaries (Figure 6.9).
Stolen goods are typically used goods and the purchase of used goods
tends to drop as income rises. However, it is not at all clear whether stolen
goods are inferior goods (i.e., that demand for them drops as income rises)
S S
P1 P1
P2 P2
D1
D2 D2 D1
Q2 Q1 Q2 Q1
Increasing criminal penalties for receipt or possession of This will, in turn, reduce the number of burglaries
stolen goods reduces demand for such goods, thus reducing committed. In this diagram, the supply function
the quantity supplied. represents individuals from whom goods are stolen
(the ultimate suppliers of stolen goods) and the
demand function represents the burglars (those who
demand stolen goods in the first instance).
Figure 6.9. Changes in the stolen property market lead directly to

changes in the burglary market.
in general because the price paid for stolen goods rises as income rises. This
is because the penalty for receipt and possession of stolen property is not
only conscation of the good but, if someone knowingly acquires a stolen
good (or ought to have known that it was stolen), they face a prison term.
The prospect of prison raises the price of engaging in criminal activity and
thus the price of stolen goods. Unless we can effectively separate the
impact of price from income, we cannot determine whether stolen goods
per se are inferior goods nor can we discuss whether their relatively inferior
vis--vis legitimately acquired used goods. If the penalty is low, acquisition
of stolen goods might be a thrill that rises with income, making stolen
goods normal goods.
In order to determine whether a good is normal or an inferior good, we
use what is called the income elasticity of demand, which measures the
percentage change in quantity demanded divided by the percentage change
in income:
(6.3)
If quantity demanded increases with income, we refer to that good

as a normal good. This would result in a positive value for the income
elasticity of demand. If the quantity demanded of the good rises faster
than income, we call the good a luxury good. If it rises, but not as
quickly as income rises, it is called a necessary good. Finally, if quantity

demanded of the good falls as income rises, it is referred to as an inferior
good. The value of the income elasticity of demand can be anywhere
from to .
In an earlier chapter we discussed the concepts of substitute and com-
plementary goods. Now we will formally dene them using a concept
called the cross-price elasticity of demand. It is the percentage change in
quantity demanded of the good in question divided by the percentage
change in price for another good:
(6.4)
Two goods are substitutes if the value of the cross-price elasticity of

demand is positive: rises in the price of one good produce increases in
demand for the other good. Think about it. If you have looking at two
goods, such as ice cream and frozen yogurt that are normally not consumed
together, wouldnt a rise in the price of ice cream cause at least some people
to switch to eating frozen yogurt?
If the cross-price elasticity of demand is negative, this indicates the
goods are complements, that is, one is more likely to consume both goods
when the price of one falls and less likely to consume both goods when the
price of one rises. A rise in the price of ice cream produces a drop in the
consumption of ice cream cones as well as ice cream.
Legally purchased goods tend to be substitutes for similar stolen or
counterfeit goods. After all, the sole difference is whether the good is legit-
imately acquired. Raising the price of legally purchased goods tends to fuel
demand for stolen or counterfeit goods. A similar phenomenon occurs
with the grey market. Remember the earlier example of textbooks? More
the difference in pricing between the international and domestic editions,
greater the incentive to enter the gray market.
At the same time, there are methods to drive up the cost of acquiring
stolen property. Vehicle Identication Numbers on cars, serial numbers on
computers and other equipment, and the etching of identifying informa-
tion in books and on property are means of increasing the cost of such
acquisition by driving up the probability of recovery. These have the effect

of reducing demand for such goods. Thus it might become necessary to
melt down gold or reassemble bicycles or cars from the parts of several
different vehicles in order to hide illicit activities.
Increased burglary also results in increases in demand for protective
services such as alarms and security guards but also for police services,
which in turn pushes up price and quantity supplied of such services
(Figure 6.10).
If supply is perfectly inelastic, the result will be no more protection but
there will be an increase in the price of the protection that is provided
(Figure 6.11). An example is the provision of protection during an emer-
gency situation. At some point, it may become impossible to increase
P2
P1
D2
D1
Q1 Q2
Figure 6.10. A rise in theft increases demand for security services.
P2
P1 D2
D1
Q
Figure 6.11. Inelastic supply leads to price increases.

supply of protective services. Triage will be performed, with ofcers

responding to more urgent needs as given by their own priority list. Such
was the case during the Los Angeles riots experienced in the aftermath of
the trial of four ofcers charged with beating Rodney King in 1992.
Similar experiences occur during natural disasters. Citizens are informed
not to expect immediate servicing of calls. With the ability of the police to
respond stretched thin, opportunities for criminal activity increase. This is
one reason for increased looting and robberies during such times of crisis.
Online Piracy
Piracy is the action of copying a digital or analog product and offering that
copy for distribution, usually via the Internet. It differs from theft (despite
what the movie and song industries would like you to believe) as it does not
reduce the physical inventory of the manufacturer. It differs from counter-
feiting as it is usually not done with the intent of making you think you are
purchasing an original or authorized copy. Individuals who buy or down-
load pirated content almost always know what they are getting is unautho-
rized by the copyright owner.
Stolen property is more injurious to the manufacturer than pirated
goods because the manufacturer not only potentially lost sales but also lost
the value of the cost of production on each stolen item. In addition, pirat-
ing intellectual property has certain time limitations on it that do not apply
to stolen property since a conviction for piracy requires the violation of
someones legitimate intellectual property rights. It is impossible to pirate
Gullivers Travels, since that exists in the public domain, but it is still pos-
sible to steal a physical book of Gullivers Travels and be sentenced to
prison for such actions.
One of the classic arguments in favor of song swapping and movie
swapping (also known as pirating) on peer-to-peer networks is it either
does not affect demand or even increases it because it allows customers to
sample music online. To the extent such an argument has validity, the
proponents are making the argument that downloaded music and legally
purchased music are complementary products. While this may be the case
when one cannot download legally, it has no validity when legal avenues
exist for downloaded music. If the medium of distribution drives consumer
demand, then when legal provision of music is afforded online, the free
method loses legitimacy as a potential sampling source.
Record and movie labels attempt to drive up the cost of illegally dis-
tributed songs and movies by posting les that appear to be legitimate but
are not. The rise in the cost to acquire such les by means of such mechan-
isms will lower demand for such illegally distributed music and movies but
also increase demand for legally acquired music and movies to the extent
the goods are substitutes for one another.
The operative words are to the extent the goods are substitutes. Record
and movie studios as well as other entities tend to make the argument that
pirated goods and legally acquired goods are perfect substitutes for one
another. However, this cannot be the case. A perfect substitute is one
where a small rise in the price of the illegally acquired good leads to all of
its demand going to the legally acquired product. Since the price of pirated
goods is lower, the presence of an illegal market cannot, by itself, indicate
there has been an equivalent loss in the market for legitimate goods. Fur-
thermore, as noted earlier, the presence of an illegal market tends to drive
up the price of legal goods, which has a further depressing effect on sales.
Thus, the amount of loss needs to be calculated not based on the actual
price that prevails in the legal market multiplied by the number of copies in
the illegal one but based upon the total revenue that would be acquired less
the cost of production if the illegal market did not exist, compared with the
total revenue that is actually acquired less the cost of production in the
presence of the illegal market.
Since some of the purchases in the illegal market would not have
occurred but for the lower price in that market, such purchases do not
impact the legal market. Similarly, used products can be thought of as cut-
ting into sales of new products but we do not consider such competition as
injurious or detrimental to the interests of the new product precisely because
it is legally sanctioned. Competition is not a tort.
Other strategies include outreach and educational programs such as
informing the public of job losses in the recording and movie production
industries resulting from illegal supply of intellectual property. This can
lead to less innovative production as producers concentrate on certain
hits as well as a reduction in the overall level of production. However,
strengthening intellectual property laws and greater enforcement of the
same does not mean countries lacking such a policy will nd themselves
without a music, book, or movie industryit merely means it is more
difcult to sustain one. Indeed, intellectual property rights are a fairly
new concept and lengthening the time allotted for copyrights might actu-
ally limit production of such property. Imagine a Walt Disney Company
unable to reach into our collective heritage to produce a Snow White or a
Cinderella because the Brothers Grimm still owned the copyright. During
the founding days of the American Republic, copyrights in Britain were
not enforceable in the United States. British book publishers either had to
publish in both countries or were caught off guard as American publishers
quickly copied the texts of books for redistribution in the United States.
This did not lead to the development of copy protection techniques or the
death of the British book industry. Instead it led to increased licensing of
books and an eventual increase in sales for all parties involved.
Counterfeiting
Counterfeiting is the crime of copying something with the intent to
deceive someone else into thinking the copy is an original. A counterfeit
is not the same as an inferior product that competes with an established
brand nor is it the same as name platting, the practice of car companies to
sell virtually identical cars under different brand names (such as Ford and
Mercury) at different prices (with only grill and styling differences).
Anti-counterfeiting measures for products include provision of warran-
ties and other benets that can come only from legally produced goods
(although some counterfeiters actually offer warranty and return policies
that are superior to those offered by the original manufacturer!), installation
of identication marks such as holograms, use of anti-copying technology
(such as installation of deterrence equipment in color photocopiers to
make them incapable of copying currency), and use of serial numbers.
United States paper currency is printed on both sides of a paper-like
cloth unique to the U.S. government and the ink is actually pressed into
the cloth. The use of cloth makes it durable. Anti-counterfeiting foils
include use of tiny color strings inserted in the currency and metal strips
inserted in the currency proper detailing the original value of the bill (to
deter bleaching of the currency in an effort to acquire the paper for use in
printing a higher valued bill). There is a requirement that more than 50%
of the bill remain intact including two of its four corners before a damaged
bill can be redeemed (although this need not be intact in a form that is
wholebills that have been re-damaged or even used as liner for birds
have been successfully recovered by special government inspectors trained
to repair damaged currency so the owners can have the value replaced).
There are numerous other mechanisms built into currency to ensure
against counterfeiting, many of which are classied and not known to the
general publicyou didnt think I was going to teach you how to coun-
terfeit in this book, did you?
The ridges one nds on coins are used to discourage the peeling off of
edges, which regularly occurred when coins were minted in silver. Indivi-
duals would shave off the edges to collect small amounts of silver, leaving a
slightly smaller coin that nevertheless was taken at face value, allowing them
to prot by the amount that they shaved. If done by an expert, changes were
almost undetectable by most individuals. Hence the need for ridges on
dimes, quarters and coins of higher denomination. Although coins are no
longer minted in silver, these ridges remain as a testament to the past.
Vandalism
Unlike other property crimes, vandalism isnt usually about making
money. It encompasses a range of acts from spraying grafti to committing
sabotage. Individuals who commit vandalism experience high psychic
income from the practice and it is difcult to deter by trying to reduce
this income since it is not realized on the open market but is instead some-
thing internal to the individual. If an individual derives pleasure from spray
painting his name across a buildings edice, the way to deter this is to
make it more costly to engage in such activities. This can be accomplished
by increasing severity or certitude of punishment or by making the equip-
ment necessary to commit vandalism more expensive. Bills designed to
keep spray paint cans out of the hands of minors by limiting their sale to
those over the age of 18 or 21 are attempts to accomplish this. Other tactics
include the provision of grafti-acceptable zones to allow individuals to
express their individuality in a controlled environment. Since the majority
of the perpetrators of such crimes are minors, these constructive solutions
may alleviate the problem by channeling budding artistic talents in a more

meaningful direction. Such solutions may not be sufcient to deter com-
puter crime, which will be dealt with later in this chapter. It also will be
insufcient to deal with sabotage, which often has a different root cause.
There the goal is revenge-based and is often committed by adult offenders.
In such cases, it is difcult to stop since a desire for revenge can consume
an individual to such an extent they discount costs dramatically in their
internal cost-benet calculations.
Arson
Arson has two basic motivations. The rst is pyromania. Such individuals
probably do not respond as readily to price signals as pyromania is a mental
illness, a compulsion on the part of the individual. On the other hand, those
who commit arson for the purposes of insurance fraud are doing so for a
different motivation, which is monetary in focus. These two activities
require very different actions to reduce them. Similar to drug addicts, one
can focus on efforts to control pyromania by creating controlled situations
for them to experiment. While controlled burn situations may act to repress
such desires, there is also a problem of tolerance that causes those addicted
to watching things burn experiment with res on a larger scale. Unfortu-
nately, some pyromaniacs become reghters who try to turn themselves
into heroes by setting uncontrolled blazes they are later called on to extin-
guish. It is probably best to attempt to identify such individuals and provide
them with mental health services designed to control and cure their addic-
tion to ames. A detailed model of pyromania follows this section.
On the other hand, the arsonist as insurance fraudster is more prone to
respond to activities designed to affect the price of his action. Some of
the activities undertaken to prevent such incidents work equally well
for all types of insurance fraud. These include requiring deductibles and
co-payments as well as ensuring structures are rebuilt in the aftermath of
calamities. Payments can be made directly to construction rms so poten-
tial nancial windfalls can be diminished. In addition, a periodic inspec-
tion of credit reports and nancial statements of rms may point to
potential problem areas requiring payment of higher premiums consistent
with higher risk of nancially-motivated arson.
For the Economist: Pyromania in General

Equilibrium
We will now use general equilibrium theory to discuss pyromania. If you
are familiar with the theory as explicated in most intermediate microeco-
nomics texts, you may nd this exposition useful. Otherwise, feel free to
skip this section.
Many microeconomic texts discuss the so-called Robinson Crusoe
economy, so named because we want to highlight the workings of a market
using the simplest possible example: a single person. In such a model, one
individual is both producer and consumer of the same good. The typical
argument makes Robinson Crusoe appear to border on schizophrenia
because these two functions are separate and distinct and he consciously
buys labor from himself as producer by paying himself a salary and then
subsequently turns around and purchases a good from himself as consumer,
paying a price that guarantees a tidy little prot for himself as entrepreneur.
In this section, we develop the equivalent of the Robinson Crusoe deci-
sion to engage in property crimes. This is since, for many such crimes, the
demander and supplier of the crime are one and the same person, although
one could conceive of the crime being carried forward in a market with a
monetary payment being made to an individual to carry out the crime by a
party interested in seeing the crime occur. Our goal is to show the market
model can work for an individual as well, even though no trade is occurring.
In this model, our antihero, Robinson Crusoe, destitute from his
return from living on an island and completely socially inept due to that
experience, learns he has only two choices in how to spend his time: he can
watch Fahrenheit 451 or he can commit arson. Committing arson is work
and Robinson doesnt like to work but he enjoys watching things burn and
if he wants to ensure he can see a re, he has to start them.
We can begin by drawing his indifference curves as given in
Figure 6.12.
Notice how the indifference curves are drawn. He likes res and dis-
likes spending time committing arson. Therefore, he needs to receive more
res if he is going to accept more arson. More res with the same amount of
arson is better as is the same amount of arson with fewer res. The higher
the indifference curve, the more utility he has.
Utility increases as we move in this direction

Fires
Time spent committing arson
Figure 6.12. Indifference map of Robinson Crusoe, pyromaniac.
Producing res is hard work. He has to search for a good place to start the
re, check to see if there are any police around as well as ensure there are no
people or animals who might accidentally meet their demise if an errant re
was started (he likes to start res but doesnt want to hurt anyone), ensure the
re can be produced quickly, and then run to the safety of a hidden location
to watch the blaze. At rst, he starts res in trash cans but soon he is moving
on to grass elds or buildings, the better to make larger resafter all, the
thrill isnt so great if he doesnt increase the size of the next re over the last
one set. Thus to gain additional res requires greater effort. We represent
this with the production function and the location where the production
function meets the highest indifference curve is the point at which we deter-
mine the amount of arson Crusoe will exert (A*) and the number of res he
will get to watch (F*). For those of you who are wondering, the line that
I draw outward to F* is a straight line that is parallel to the x-axis. That it
appears to be drawn at an angle is an optical illusion (Figure 6.13).
At the point where the production function and the indifference curve
meet, the marginal rate of substitution (the slope of the line tangent to
the indifference curve at that pointalso known as the derivative of the
indifference curve) is equal to the marginal product (the slope of the line
tangent to the production function at that pointalso known as the deriv-
ative of the production function). Thus, the amount of production that
Robinson Crusoe gets from that extra hour of arson must equal the value
that he places on watching Fahrenheit 451 (which is what he gives up to
Fires
F*
Production function
A*
Amount of arson supplied
Figure 6.13. Figuring the optimal amount of arson.
commit arson). If this were not the case, our utility-maximizing pyroma-
niac would either commit more arson (if the marginal product were
greater) or commit less arson (if the marginal rate of substitution were
greater). If he could watch two res by committing an extra two days plan-
ning and executing arson but he thinks he should watch three res from
working that period of time, why would he work more? Similarly, if he
could watch three res from working two days committing arson and he
only needs two res to make him want to work and two days committing
arson, why would he work less?
Now Crusoe was on that desert island for a very long while and he went
a little bit crazy trying to sort all of these possibilities. One manifestation of
this insanity is he decides to pay himself to produce res. To ensure he still
will produce the proper amount of res, he decides to set up a prot-
maximizing rm called Pyromania, Inc., with himself as the sole share-
holder. He then pays himself a wage. He then sets up a currency called the
dollar and prices res at one dollar each. Voila! We have our numeraire
good, that good which all other goods are valued. Now the question is how
much should he pay himself per hour?
The solution is actually the same as when Crusoe was working by him-
self. The rm will try to maximize prots so it will produce at the highest
isoprot line that it can nd that is tangent to the production function.
Since the price of res is xed at $1.00, the only thing that can vary is the
Fires
F*
Isoprofit
line
Production function
A*
Amount of arson supplied
Figure 6.14. Pyromania, inc.s optimal production of fires.
wage (higher wages induce more arson but they cost more so the goal is to
set the marginal value product of labor equal to the wagesince the price
of the re is $1.00 the marginal value product equals the marginal product
in this case). Similarly, Robinson Crusoe, as the sole laborer will seek to get
a wage that can offset his dislike for working. He will seek to set the wage
equal to his marginal rate of substitution. But wait a minutethat means
that the wage is equal to the marginal rate of substitution and the marginal
product, which is exactly what we had before we set up a labor market and
a market for res (Figure 6.14).
The market has functioned efcientlywith rational self-interested
participants, the same choices are made in the face of the market or if
Robinson Crusoe made the decisions by himself without the labor market.
This model can also be generalized to the market with hundreds of parti-
cipants. The point is that even though a single individual does not trade,
he still might behave precisely as if he had traded. As such, the model
works even if no market transaction actually occurs.
White Collar Crime

This nal category is a catch-all one encompassing what many consider
stealth forms of criminal behavior, criminals operating not with a gun but
with technology. In some ways, they can cause far more damage than
traditional banditry but until very recently such activities met with rela-
tively light sentences.
Fraud may be divided into several different categories: the most obvi-
ous being insurance fraud, securities fraud, embezzlement/employee theft,
and identity theft. The rst was dealt with in the section on arson. Secu-
rities fraud is a mechanism by which an employee or other individual with
insider knowledge, usually in a nancially sensitive position, is able to, by
virtue of access to critical information or nancial accounts, defraud share-
holders through insider trading or other securities fraud. A few recent
examples highlight this type of behavior in its various forms.
One way to commit securities fraud is the misstated earnings report,
examples of which were perpetrated by WorldCom and HealthSouth.
In an effort to increase the price of securities, insiders will book phantom
transactions as revenue, engage in transfer pricing (the pricing of internal
transactions within a rm for purposes of reporting prots and losses in
different tax jurisdictions, usually with the desire to increase prots in the
jurisdiction that will tax least, while reducing them in the jurisdiction that
will tax) inconsistent with rules for such practices, or accelerate deprecia-
tion improperly.
Securities fraud can also occur when there are insufcient auditing con-
trols in place, allowing individuals to accumulate vast losses without proper
oversight. This falls in the category of securities fraud because the actions
that occur allow the rm to trade at far above its fair market value. One
example is Barings Bank. Singapore-based trader Nick Leeson shufed
money between accounts in Tokyo, London, and his home base of Singa-
pore in an effort to increase prots through arbitrage trading (the action of
buying and selling simultaneously in two markets to take advantage of
slight differences in pricing) and band trading (placing a bet that a currency
or security will remain within a set band or move out of that band over a
xed period of time). His simultaneous status as general manager of the
Singapore branch, running the back ofce at that branch, and as the
rms leading trader led to enormous gains for the bank but also exposed
it to signicant risk. At one point, his power on the Japanese yen market
was sufcient he could normally move the market in the direction he
wanted. However, his short straddle position on the Japanese yen on the
eve of the Kobe Earthquake, which caused a dramatic drop in the Japanese
currency, proved his undoing as he was unable to alter the course of a

market collapse. This type of fraud is perpetrated with the idea of acquiring
higher status within a rm or greater bonuses.
A similar circumstance occurred with Sumitomo Corporation, one of
the worlds largest nancial institutions. Hamanaka Yasuo was the chief
copper trader and he and his team controlled 5% of the worlds copper
supply and accounted for up to half the transactions on the London Metals
Exchange. His actions could move markets and he continued to try to prop
up the metal by withholding supplies from the open market, an action that
put his trading into focus from oversight agencies concerned about market
manipulation. When George Soros and other investors sought to push
down the price of copper while Yasuo attempted to prop it up, the conict
brought to a head a scheme that cost the rm more than $1.8 billion when
copper prices nally dove. Through a series of deceptive accounting prac-
tices that could only be accomplished because Yasuo bypassed the back
ofce to take personal control of trades, his actions resulted in the greatest
nancial loss pinned on a single individual in the history of nance.
Insider trading is one of the most familiar types of securities fraud. An
example was perpetrated by Martha Stewart. She wasnt an employee but
rather was a client of a stockbroker who gave her inside information (infor-
mation not known to the general public) on another stock. By taking
advantage of that information, she was able to avoid a loss of about
$45,000 when shares of ImClone, the stock over which she was given a tip,
fell on news its new anti-cancer drug was not being approved by the FDA.
Another way to commit fraud is the Ponzi scheme. Charles Ponzi, in
the 1920s hit upon the idea of paying earlier investors promised prots out
of the payments of later investors. This created the illusion of prots when
actually the last person in paid the rst person out and then nancial
records are doctored to maintain this ction. Barry Minkow, Bernard
Madoff, and Allen Stanford are modern-day examples whose exploits only
serve to prove if it seems too good to be true, it probably is.
Another method is hawking so-called penny stocks over the Internet.
Through hype individuals can sit at a computer and rapidly move stocks
through word-of-mouth discourse. Known as stock pumping, or the
pump and dump, it typically consists of an individual who may or may
not be connected with the company talking up the virtues of the stock and
how it is about to be the next Microsoft. Initially, he might buy the stock
and then pump up the price by hyping it. He then sells his stock and
might even engage in short selling when he stops his rhetoric. Then when
the stock falls in price, he buys the shares back, making money on both
sides of the deal.
Embezzlement is taking from a company or client money belonging to
that company or client and converting it to private use, while employee
theft usually involves theft of physical inventory. Numerous techniques
have been instituted by employees over the years to affect such transfers
of wealth. Common techniques range from shoplifting to more elaborate
schemes. In cash businesses, especially those without clearly marked prices,
these practices occur more often. An employee might fail to ring up a sale
and pocket the money instead. Another practice is to disable security tags
and thus remove products from the store in that fashion. They might team
up with a shoplifter who will switch tags on merchandise so it appears to be
marked down, then they return it with a correctly marked tag without a
receipt to receive the difference in cash.
However, the most protable types of embezzlement involve the use
(and abuse) of technology. In the book Computer Capers, Thomas White-
side1 reports several types of embezzlement including the infamous salami
technique, so named for the thin slices of meat one can purchase at the
grocery store. In this attack, an employee of a rm steals small sums of
money (often as little as fractions of cents) from a large number of accounts
and then deposits these funds into her own account. The potential haul
may make it protable. If 2 million accounts were attacked with an average
of 1/10th of one cent diverted each month, one could steal $2,000 per
month. In fact, according to Whiteside, such an attack did occur and when
the person was arrested, a determination of fact by the judge was that the
theft was not from the nancial institution but from individual account
holders. While this might appear to be benecial because the number of
counts of embezzlement would now increase exponentially, the reality was
far different. Bizarrely, since no theft amounted to even a single cent, it was
declared by the court that nothing of value was taken, the requirement for a
theft to occur. Such a judgment dees common sense since the total
amount taken was of value. This case is, therefore, of questionable
authenticity.
There are numerous other examples of computer crimes ranging from

hacking a website to creating computer viruses (these are similar to vandal-
ism as they are committed not for nancial gain but for private glory) to
simple variations on fraud that used to occur through the mail before the
advent of the Internet.
Yet the most diabolical white collar crime thus far invented is identity
theft. A person acquires credit in anothers name using stolen nancial
information, often nothing more than a birth date, name, and social
security number. With these three pieces of information, one can access
almost any nancial record available and can also nd the persons
mothers maiden name, often used as a secondary security marker for such
data.
Of a lesser degree of maliciousness are those individuals who steal credit
cards or ATM cards and raid the credit card or bank account of the victim.
Although these losses are generally made up by the nancial institutions, it
can be a hassle in these days of easy credit to have to close an account or
wait for the bank to replace the stolen money.
Some victims of identity theft have had babies registered in their
names, credit taken out (and subsequently ruined), tax liens placed against
them, and even criminal records created (by the perpetrators who give sto-
len identities instead of their own identities to the police). Others have
been mistakenly placed on terrorist watch lists.
Unless crimes are punished appropriately, they will continue to be per-
petrated. The problem is most of these crimes have very low clearance
rates, meaning it is easy to get away with the crime when compared with
other crimes. Indeed, computer crimes often do not leave an easily acces-
sible trail or that trial is quickly covered up because the victims of the com-
puter crime are unwilling to come forward and report it.
One possibility is to increase the cost of committing such crimes.
When they are perpetrated by individuals against the corporations that
employ them, redundancy checks can ensure individuals are not approving
actions they undertake without external oversight. Trusting an employee
simply because they are doing well by the company can sink it as was seen
with Barings Bank. Similarly, allowing computer code to be written with-
out having others examine it critically and not building in audit trails for
changes in that code can lead to salami attacks and worms being inserted
that can create opportunities for embezzlement and malicious mischief.

Laws that limit the selling and buying of stock by insiders and investiga-
tions into large gains realized and losses avoided immediately after dramatic
swings in a stocks price increase the likelihood of detection of insider trad-
ing. We might also increase penalties for such behavior, likening the fact
that it matters little how the theft occurred as compared to the size of it.
Indeed, given the magnitude of some of these thefts, there is actually a solid
rationale for enforcing very lengthy prison terms or even the ultimate pun-
ishment of the death penalty. One can kill someone by taking away their
livelihood and thus a push of a button can trigger events every bit as deadly
as ring a bullet.
We could also try to decrease benets. One way is to increase the mar-
ginal tax rate on the wealthiest individuals, especially on capital gains and
bonuses. Although this will have other consequences such as altering legit-
imate incentives to work longer hours, it will reduce incentives to engage in
insider trading, stock pumping, and trading schemes.

1. How can recipients of counterfeit bills actually benet from receiv-
ing such bills?
That counterfeiting helps the counterfeiter should be patently obvious.
He is receiving goods worth far more than the (worthless) paper he is
trying to pass on to another. However, the recipient also benets pro-
vided she are able to pass on the bills to another before they are discov-
ered. Suppose Bill counterfeits $20 and gives it to Anne. Bill has
received $20 worth of goods for substantially less than $20. Anne now
has a worthless piece of paper but, if she passes it on to Ted, she is made
whole in the process. Ted discovers he has a counterfeit bill and turns it
in to the police but he has no idea where it came from. Ted is out $20.
Anne is made whole by the transaction and Bill, in essence, stole the
money from Ted, not Anne. If the bill is never discovered, the calculus
changes. Although Ted (theoretically) is out the money, since it is never
discovered, his wealth has not diminished at all! So where did the $20 of
value go that Bill stole? It is stolen from society at large with increased
prices, which usually take a while to be affected after counterfeit money
is in circulation. Until prices actually rise, passing on a bill makes one

no worse off and actually makes one better off (since one was able to sell
faster than otherwiseremember, money earned today is worth more
than money earned tomorrow so an earlier sale, even to a counterfeiter,
is better than a later sale, provided the counterfeit bill is not detected).
In the end, we all pay a bit more but those who receive the stolen bill
are made whole by the practice since their worthless bill is never
detected.2
2. Discuss how pimping a prostitute can be a victimless crime.
We have already established prostitution is a victimless crime and
pimping is no different, so long as there is no coercion. The pimp pro-
vides a valuable service for the prostitute: by having a pimp, the pros-
titute is able to ply her trade without searching for customers or having
to handle cash at the same time she might be most vulnerable to theft
(i.e., while changing after having sex). Both prostitute and the pimp
are trading based on their own comparative advantage: one is better
able to provide the sex act and the other is better able to handle the
nancial transaction. The pimp takes a cut but that is payment for
services rendered. If you go to legal brothels, you will nd the person
in charge of advertising and collecting money is not the prostitute. The
prostitutes time is better spent in the sexual act itself, while the
pimps time is better spent advertising the prostitutes services and col-
lecting money.

1. Thinking about the incentives of criminals, what are some ways that
you can protect yourself from identity theft?
2. In China, white collar crime is often punishable by death. Con-
struct an economic argument as to why this is an efcient and just
penalty.
CHAPTER 7
Crimes Against Persons

The scariest crimes for most people are those against persons, so-called
violent crime. These fall into three general categories: murder, rape (encom-
passing all forms of sexual assault including those against children), and
assault. Our most severe penalties are reserved for perpetrators of such
offenses. Even though violent crime in the United States has been on the
decline for many years, we still have a perception we are not safe.
Contrary to the perception of murder and rape as crimes that occur
at random, these crimes of violence often are committed by acquain-
tances or family members. A common factor is the need to be physically
close to the victim. While a house can be burglarized when no one is
present, it is much more difcult to accomplish violence without physical
proximity between perpetrator (or agent in the case of murder for hire)
and victim.
Murder
We can think of murder as being divided, like drug use and arson, into three
distinctive groups: murders of passion, serial murders, and murders for
prot. Murders of passion are committed with short-term consequences
reigning supreme. They are less likely to be calculated with all variables con-
cerning potential capture and punishment in advance, although these might
be of concern once the murder has actually been committed and the task
turns to covering up the tracks so as not to get caught.
This manifests itself in the form of highly inelastic demand supply
functions (Figure 7.1). Shifts in the supply or demand curve, if not done
in tandem, will tend to alter price but not vary quantity by much. Since the
price is a psychic one in the case of a crime of passion, its value is of less
material concern than the quantity of murders.
It might be easier to simply drop our assumption of rationality in
the commission of crimes of passion and assume irrationality. Supply and
P*
Q*
Figure 7.1. Murder of passion.
D=S
Q*
Figure 7.2. Irrational murder.
demand would be one and the same, both perfectly inelastic and unrespon-
sive to price signals (Figure 7.2).
No matter the price, the desire to murder is foremost in the mind of
the offender. Whether the penalty is a small ne or the death penalty sim-
ply does not matter: at the time of the killing, all that matters is the death of
the person the individual wishes to see dead. Of course, such a situation
may also occur with perfectly rational individuals as well. Suppose that a
couple nds their son kidnapped. Instead of demanding money in return
for the childs life, the kidnapper tells the grieving parents the father must
murder another person if he wants his child to live. Such a situation will
probably cause some fathers to discount any incentive a democratic gov-
ernment could provide either positively or negatively to inuence the
decision.
So why would we still impose a penalty for crimes of passion if people
will not respond to price signals? There are two basic reasons. First, we
CRIMES AGAINST PERSONS 153
want individuals to control their emotions and a penalty associated with

bad behavior can help individuals who are susceptible to emotional swings
seek treatment before they are presented with a triggering event. A second
reason is if you create an exemption in law for some actions, an unscrupulous
individual whose actions do not actually fall within the category of exemp-
tion will attempt to create circumstances to make it appear as though his case
is equally deserving. This is a moral hazard problem and it creates situations
after the law has been written that make it so people will nd loopholes to get
themselves off. The classic Alfred Hitchcock thriller Strangers on a Train is
one such case where two strangers conspire to murder the others victim,
thus allowing each the perfect alibi.
Another scenario is when a husband might co-conspire with the lover
to arrange for the tryst and then kill the wife while then telling the lover
to leave. Of course, the two men would have hatched the plot weeks earlier
to dispose of the wife. Thus we still may prevent some murders by punish-
ing crimes of passion even if they are only those made to look like a crime
of passion had occurred. Another reason may be to exact retributive pun-
ishment. Punishing someone for wrongdoing can aid in making the
victims family feel better. Ironically, this is exactly the same reason which
drives people to kill: to reduce negative thoughts about another by getting
rid of the problem (the other person).
There is only one exception that is afforded to most individuals, the
category of self-defense, but even this has limits. One can inict deadly
force to save ones own life or that of another but not the life of an animal,
and one cannot use deadly force once the individual is no longer a viable
threat, such as when his back is turned to ee.
In any case, when supply and demand curves overlap, prescriptions to
alter them must be met with skepticism. After all, the two curves are one
and the same. Reducing the cost or increasing the cost of murder by shift-
ing the supply curve up or down will do absolutely nothing to alter the
number of murders. Altering the taste for murder to alter demand is also
likely to meet with failure since the desire to kill is so overwhelming in such
cases as to completely dominate all other impulses.
This does not mean that the economist is left without a potential policy
prescription. Decreasing the likelihood of circumstances that would bring
about a crime of passion will now occupy center stage. Since crimes of
passion are, by denition, unplanned crimes of opportunity, one can sim-

ply try to reduce the opportunity to murder. One possibility is increased
handgun control. Since irrationality tends to be a temporary state for most
individuals, anything that reduces the likelihood a handgun will be in the
possession of the individual at the time passion struck would reduce the
incidence of irrational murder.
Controls may be designed to reduce the number of handguns in the
home at the time of such feelings of anger, such as increasing the waiting
period for handgun sales or increasing costs of handguns through taxation.
Controls might also be designed to slow down such activities by requiring
guns and ammunition be kept separate and locked away prior to use.
Anything that increases the amount of time between the initial ashpoint
of anger and potential use of the gun will likely have some mitigating effect
on the quantity of irrational murder. We will discuss gun control further in
Chapter 8.
Other possibilities include tactics designed to diffuse situations that
may erupt into violence, public education campaigns, and regulation of
violence in television, movies, and video games, all of which are linked to
increased aggression in children and adults.
Turning next to serial killings, the sociopaths response to punishment
needs to be considered in devising a proper public policy strategy. The
severity of the punishment cannot be increased in most multiple murder
cases so the only variable under the supply function that serves to assist us
in this effort to reduce criminal activity is the probability of punishment.
However, it is unclear whether the death penalty or life imprisonment
without the possibility of parole is the more severe penalty from the stand-
point of the sociopath. Indeed, if we look at people with a martyr complex,
an increased likelihood of a death sentence may actually act as a perverse
incentive to kill. It is entirely possible a similar motivation, or perhaps for
infamy, motivates serial killers, some of whom, such as Aileen Wuornos
and Gary Gilmore have actually called on the state to execute them.
In the case of terrorists, such as Ted Kaczynski, Osama bin Laden, and
Timothy McVey, each saw himself as advancing a cause and thus had a
different calculus than those who saw the actions as a sadistic desire to hurt
individuals. To people like Kaczynski, bin Laden, and McVey, individual
deaths are casualties in an ongoing war over ideology. They see individuals
less as human beings and more as pawns in a grand game between them-
selves and civil authorities. The weapon of choice is the bomb and other
non-personal methods that devalue the humanity of the individual lives
they take.
On the other hand, serial killers such as Jack the Ripper, the Boston
Strangler, the Night Stalker, BTK Strangler Dennis Radar, and the Zodiac
Killer have no such ideological tendency. Their attacks had other motives:
sexual or occult-related.
Finally, there are mass murderers who kill at a single place and time a
large number of people or spree killers who kill in multiple locations over a
very short time span. The motivation in each case is usually rage and it is
often personal in nature.
The sociopath, unlike the irrational murderer, often takes deliberative
steps to avoid capture. He thus might be more likely to respond to changes
in the probability of capture than in the nature of the punishment itself.
Yet, except for focusing on the root causes of serial killing, which may
include the extreme levels of violence found in todays media and popular
culture, there is little economists can add to the work of psychologists
studying the patterns of serial killing. Serial killers, spree killers, and mass
murders dont, as a general rule, respond well to incentives.
Financially-motivated killers, including contract killers, obviously do
respond to incentives. Financially-motivated killing enjoys a special place
in the denitions of criminologists. Even if the activity results in the deaths
of a large number of individuals over a lengthy period of time, they are not
labeled as mass murderers, spree killers, or serial killers. William Burke and
William Hare terrorized Scotland in the 1820s and sold the corpses to
Dr. Robert Knox who used them in his anatomy classes but they are not
considered to be serial killers due to their nancial motivation. Terrorists
are not considered to be serial killers because political motivation drives
their criminal actions.
The relevant determinants can be drawn using a graph of supply and
demand. In the case of contract killing the supply function encompasses
those who actually carry out the criminal activity (the contract killers)
while the demand function is dened by those who seek such killers.
In cases where the individual who prots from the crime is also the one
who is committing it, the supply and demand functions are internally
driven. Murders that will typically not go punished, like female infanticide
in pre-Islamic Arabia, carry with it a very low cost and, therefore, a higher
incidence. The prohibition against infanticide under Islamic law was cred-
ited with a dramatic drop in such killings.
The demand for murder will shift based on several factors related to the
demand of any good. First, if attitudes towards killing change, we can expect
a shift in the demand curve. The beating of slaves to death was not consid-
ered murder in many jurisdictions. This resulted in cheapening the lives of
slaves and caused additional beatings and deaths. Widespread violence in
popular culture may have a desensitizing effect on todays populace, making
murder a more acceptable alternative for dispute resolution. As noted in
Chapter 2, wealth effects are ambiguous and depend on the expected prob-
ability of eventual punishment. The impact of a prison term (or execution) is
likely to result in a greater monetary loss for the wealthy than for the poor.
This does not indicate murder is an inferior good whose demand drops as
income rises. Instead it means the price paid for a murder rises with income,
causing demand for it to drop. The income effect, which is given when the
price is held constant, is still ambiguous.
If the goals of murderers can be achieved through alternative means,
relative costs of these means are important. A substitute good, in some cases,
for murder is blackmail. If the penalty for blackmail increases relative to the
penalty for murder, this causes a decrease in demand for blackmail and an
increase in demand for murder. Similarly, dropping the death penalty, by
making murder relatively cheaper compared to other crimes will decrease
demand for those other substitute crimes and increase it for murder. Thus,
the imposition of three strikes laws will make murder of witnesses more likely
since the penalty for three strikes of life imprisonment means the marginal
penalty of murder is not as great. Similarly, if we pass a law that dictates the
death penalty for rapists and kidnappers, we should not be surprised if the
victims of these crimes end up as victims of murder as well. The dead simply
do not talk as well as the living. Getting tough on crime other than murder
might end up causing additional murders.
The transaction costs associated with murder tend to be minimized
when the individual desiring the murder carries it out himself or herself.
However, if we wish to reduce murders, increasing transaction costs for
contract killing is a good start. Thus it may be better policy to negotiate
plea agreements with contract killers than with those who demand the
services of these killers. This will have the effect of increasing the transac-
tion costs of hiring such individuals and, therefore, should lower demand
for their services. Recent innovations, such as the Internet, have likely
reduced transaction costs, especially of the information-gathering variety,
for those who wish to have such crimes undertaken. Al-Qaeda terror cells
use the Internet to communicate with each other and it is likely it has also
been used to set up murder for hire transactions.
Any communication technology can reduce transaction costs for illicit
activity. In a well-known case, Eimann v. Soldier of Fortune Magazine, the
mercenary publication was sued over what was alleged to be a thinly veiled
classied ad offering contract-killing services. When the individual who
advertised in that magazine later was involved in a killing for hire made as
a result of that ad, the magazine was sued by the family of the deceased and
a Colorado jury rendered a $9.4 million judgment against it. The judg-
ment was later reversed on appeal. However, a more explicit advertisement
offering contract killing services in the same magazine a few years later did
result in a judgment against the magazine for $4.3 million. This decision
was later afrmed by the U.S. Supreme Court. This reasoning was similar
in that case as in MGM v. Grokster Ltd, when the peer-to-peer software
provider was found to be liable because it not only knew its software was
being used for illegally trading copyrighted material, its actions showed it
actively courted the market by catering to an audience that wished to
engage in such activity.
The supply function for murder is going to have an upward slope, for
as the gain from murder rises, more of it will be supplied. Revisions to
divorce laws that have granted a more equitable distribution of marital
assets have probably also increased the prevalence of spousal murder since
gains from such actions (not having to split the marital assets) have
increased. The imposition of capital punishment may have an effect on
deterring rst-time murderers but, since the actual likelihood of execution
is minimal, the deterrence effect cannot be easily determined. The condon-
ing of state-sanctioned murder via an execution process can lead to a
brutalization effect wherein life is seen as being cheapened. Even more
problematic is the near canonization of some of the more vicious killers
such as Jesse James and John Dillinger in the American mythos and the
media circus that has surrounded some executed individuals such as John
Wayne Gacy may have created an increased taste for murder by those who
crave the spotlight. Gangster movies and TV shows perpetuate this prob-
lem by romanticizing criminal activity.
Assault
Assault has similar characteristics to murder except the victim does not end
up dead at the end of an assault. When used to intimidate, assault can
result in nancial gain. Roughing up individuals may be contracted for the
same reasons as contract killing and the analysis given for murder can gen-
erally be applied to assault cases with the exception of the discussion of the
applicability of the death penalty as a deterrent. Undoubtedly, irrationality
also plays a role in assaults as individuals get angry and sticuffs begin.
At times, assaults result in death and charges are upgraded to homicide.
Deaths occur more frequently with certain weapons, such as knives and
guns, than with bare hands. One way to deter the use of weapons that lead
to a greater incidence of death is to increase penalties for their use. Use a
gun, go to prison, a tag line for one such policy, was intended to reduce
the level of violence, even if it did not reduce the number of incidents.
Violence for Hire

The principal-agent problem asks the question How do you get someone
who is working for you to do what you want instead of what he wants?
The solution is to nd the right set of incentives. This becomes more
problematic when the activity is a murder for hire because of its very ille-
gality and the possibility of stiff punishment.
One way to accomplish this is by not paying the contract killer the full
fee until completion of the job. The contracting agent may decide to use an
escrow system, placing the money with a third party, as a good faith gesture
to satisfy the need for proof that payment is forthcoming. The other possi-
bility is the contract killer needs no such reassurance. After all, a deadbeat
who fails to pay for a contract hit will likely be the next victim. The contract
killer is unlikely to kill an individual who contracts with him so long as he
believes he is in a business relationship that might lead to the generation of
goodwill and potential leads to other such opportunitiesone normally does

not advertise such services in the open and certainly one doesnt advertise in
Soldier of Fortune magazine after it was found culpable for an advertisement
for murder for hire.
Often there is a demand of proof the hit was actually carried out.
Retrieval of an item of a personal nature may be requested if the body is
to be disposed of in a way so it is not found or the payment may be con-
ditional on the death being reported in the local papers.
Since the principal reason for hiring someone else to kill another is to
produce an alibi for the time the murder was taking place, it is often neces-
sary the killing occur at a specic time and place. Other potential require-
ments may include making it look like an accidental death, especially if the
murder is undertaken to produce an insurance payout, or even via a specied
set of circumstances to ensure that double indemnity coverage is realized.
Such actions, however, raise the likelihood of capture for both parties.
A nal consideration is the nature of experience. Since few individuals
have experience in the ner points of murder and in making it appear to be
a natural or accidental death, it is likely the market price for such types of
hits is quite high. Experienced contract killers will command a premium in
the business given their ability to escape detection. This makes murder
for hire something few individuals will be able to afford. Yet the use of a
professional killer should result in a lowering of detection and be of great
interest to the wealthier or well-connected individual desiring the elimina-
tion of a rival or a spouse, especially if the contracting individual tends to
be risk-averse.
March1 discusses how a risk-averse government ofcial might enter
into an agreement with organized crime for a nancially-motivated murder.
The government ofcial may be able to stie investigation into the case and,
since she has an airtight alibi, her own involvement will not be questioned.
The case will be closed as an accident and the distraught ofcial may benet
not only nancially, but even politically, by those who rally around her for
having lost a spouse or close friend.
The principal-agent problem can be expanded to any type of behavioral
situation, not just one dealing with ensuring a contract hit goes off as
ordered. All it entails is getting the incentive structure right so the agent
(the person carrying out the task) has the same interests as the principal
(the one who wants the task undertaken). Want to ensure the contract
killer doesnt turn states evidence? Arrange for another contract killer to
visit her husband and kids if she decides to cooperate with the police.
Ultimately, one of the difculties of being in a democracy is that dem-
ocratic governments dont engage in tactics that would potentially safeguard
them against all risks. That is also one of the strengths of democratic gover-
nance. Threatening to blow a suspects brains out if he doesnt talk, arrang-
ing for penalties to be exacted on his family instead, sexually abusing him,
physically torturing him to get him to talk, these are the types of actions that
will likely get suspects to confess. Unfortunately, they are also the types of
actions likely to get innocent people to confess. The problem of incentives
having unintended consequences rears its ugly head, notwithstanding the
fact such actions violate the very principles upon which democratic govern-
ments are founded.
Rape
Rape is different from other crimes we have modeled. It is typically per-
formed by a single individual and the benets are almost always exclusively
psychic as opposed to monetary. The harm caused to the victim is oftentimes
more psychic than physical but the effects of the harm may last far longer
than an assaults injuries would. Rape is a crime of power, not passion. It is
about control. Rape victims are disproportionately female, perpetrators are
disproportionately male, and it is the least reported of all crimes, according
to victimization surveys. It is usually a planned crime as opposed to one of
opportunity. To the extent it is a crime motivated by rational action, it can
be described by our supply and demand curves, similar how we dened our
murder for prot market.
In this case, it matters little to us whether the price is high or low as the
benets derived from the practice are purely psychic. Thus activities
designed to reduce both the supply and the demand for rape are desirable
from a public policy standpoint. Reducing the supply implies increasing
the costs of rape to the rapist. This can include more severe penalties for the
commission of rape and greater police resources devoted to trying to appre-
hend suspects. Another action is the issuance of pepper spray or mace to
civilians and promotion of self-defense classes for women. One objection
to the use of self-defense is it might antagonize the rapist into behaving

even more brutally if it fails.
Suppose a woman has a concealed weapon permit and has a handgun
in her purse in case of attack. For the woman concerned, the question of
whether to use force to repel the attacker comes down to whether she
believes (a) she can successfully repel the attacker; and (b) if she is unsuc-
cessful, will this cause an increase in her own suffering at his hands. On the
other hand, armed resistance likely reduces the number of attempted rapes
in the aggregate. If 1 out of every 3 women carried a gun and she had a 1 in
10 chance of using it correctly to kill or incapacitate her assailant, the costs
of committing a rape increase. More guns may mean less crime and if the
identities of those with concealed weapons is unknown by the public, the
uncertainty of meeting the barrel of a gun may deter rapists and other
violence-prone individuals from committing violent acts.
Other possibilities include public education campaigns to reduce the
incidence of female hitchhikers and encourage women to go to bars in
groups as opposed to alone. The buddy system not only works for saving
lives from drowning but a watchful eye over drinks at all times while one
woman is freshening up in the bathroom can reduce the likelihood of date
rape drugs, such as Rohypnol, being used to spike drinks. To the extent
such drugs are used in the commission of rapes, laws increasing penalties
for possession can be increased to increase the cost of committing rape.
Decreasing demand implies actions undertaken to reduce the urge to
rape among prior rapists through counseling, medication, or castration,
whether chemical or surgical in nature. Unfortunately, it is harder to deal
with those who have never been convicted of rape. The question of
whether pornography is a substitute or complementary good with regard
to rape is one that must be developed empirically, although it is likely to
be a substitute good for some individuals and a complementary one for
others, making it even more difcult to devise an effective public strategy.
Other worthwhile goals, such as increasing the social standing of women,
might produce a backlash against women due to heightened feelings of
emasculation among men more prone to violent behavior, thus resulting
in more, rather than fewer, rapes. This does not mean these goals should
not be sought but rather we must understand there may be unforeseen
consequences.
Hate Crimes
Why do we punish hate crimes more than other crimes? The rationale must
come, if based on an economics perspective, from a perception there is a
greater harm done. This could be based on two different possibilities. First,
hate crime might cause greater harm to the individual who is attacked.
Second, even if the hate crime causes no greater harm to the individual, it
might cause greater harm to society. Hatred itself is a cause of disutility in
society. If we can reduce the level of hatred, everyone will be better off.
Hatred-based activities also cause extra avoidance costs in individuals
who might become victims. If one group systematically attacks another
group for being in a certain area of town, the rational victim may decide
to avoid that area. Avoidance of situations that might place one in danger is
systemic in society yet it a hatred-based situation is usually broader in
nature than one that is more random. Blacks in the racially segregated
South learned not to frequent certain locations and these locations were
greater in number than where whites chose not to present themselves.
While a downtown might be the hub of violent activity, avoided by all,
there would be additional places where blacks would feel unwelcome. This
caused a reduction in potentially protable interactions for all blacks.
Thus, hate-based crime reduces welfare more than non-hate-based crime.
We now have a rationale for penalty enhancement. Similarly, there will
likely be more modications of behavior to avoid hate-based crime. While
everyone might undertake behavior modications designed to reduce vic-
timization (carrying mace for self-defense comes to mind), victimized
groups will perform more actions to reduce the probability of being vic-
timized. Homosexual individuals will choose to forgo showing affection in
public or the display of stereotypical behavior that might draw attention.
The criminal might have as his goal the terrorization of a particular
group and a desire to place that group into the second tier of society.
Targeting one individual for victimization actually targets all members of
the group. The Ku Klux Klan regularly attacked blacks and Jews. Members
of those groups engaged in preference falsication and took on the status of a
subordinate group in society, subjugating their will for that of the majority.
These factors make hate-based crime more costly for society and, therefore,
enhancing penalties for such behavior benets society in general.
Those with a taste for discrimination implicitly have lower costs or

receive higher benets from engaging in such activity. When discrimina-
tion is endemic in society, such activity may go unpunished or achieve a
lighter punishment otherwise. This, in turn, increases the likelihood such
attacks will occur going forward. Even today, a victims race is a determin-
ing factor in whether a murderer receives the death penalty, with murderers
of blacks being less likely to have a date with the executioner than mur-
derers of whites. We will discuss the racial differences in punishment in
Chapter 8.
Notice that in no circumstance are we applying a standard of fairness,
although we could do so and come away with similar conclusions. Attacking
someone on the basis of physical characteristics or behavior patterns is not
considered an acceptable rationale and we might want to deter this behavior
on its merits just as we deter terrorism even if the underlying cause is just.
If our goal is to ensure individuals in society face similar odds of victimiza-
tion, enhanced penalties for hate-based crime would go a step in that
direction.
Hate-motivated crime creates greater net benets for criminals and
thus needs a greater penalty to deter. It imposes greater costs on targeted
groups who engage in victim avoidance tactics. It also imposes costs on the
wider society. As tolerance tends to be a function of contact, lack of contact
between diverse groups breeds intolerance. The reduction of hate-based
crime can only be achieved by increasing mutually protable exchanges.
As this requires the reduction of hate-based crime so the victimized group
does not engage in avoidance activities to reduce these exchanges, punish-
ing such crime at a greater rate than other crime not only sends a signal
such actions are not tolerated, but encourages a reduction in the very
hatred that caused the violence in the rst place.

1. Why is gun control more unpopular in places where violent crime
exists?
Gun control makes it much more costly for honest citizens to own guns,
thus reducing their ability to defend themselves. In areas where there is
a lot of violent crime, the desire to protect oneself becomes paramount.
2. One possibility to reduce the marginal cost of committing addi-

tional capital murders is to increase the painfulness of the execution
method. Why dont we bring back drawing and quartering?
The marginal cost may be increased but it would also serve to cheapen
human life, thus making murder more palatable. It is unclear whether
such methods would reduce murders or increase them.

1. The felony murder rule states that when someone is killed in the
commission of another felony, culpability for the murder falls on all
those who took part in the felony, not just the person who struck the
fatal blow or who shot the individual. It also applies when the death
may be linked to the crime, so that a heart attack during an
out-of-control arson can result in a murder charge against the arson-
ist. Discuss how this rule may lead to fewer murders and also how it
may cause additional murders.
2. Aggravated and mitigating circumstances can result in more severe or
less severe penalties. Discuss, from an economic perspective why each
of the following is an aggravated or mitigating circumstance:
a. Murder of a police ofcer (aggravated)
b. Remorse (mitigating)
c. Cruel and inhuman killing (aggravated)
d. Duress (mitigating)
e. Contract killing (aggravated)
f. Defendant is a minor (mitigating)
g. Witness killing (aggravated)
h. Victims consent (mitigating)
i. Terrorist killing (aggravated)
j. No prior criminal record (mitigating)
k. Multiple murders (aggravated)
l. Defendant has diminished capacity to distinguish right from
wrong (mitigating)
CHAPTER 8
Public Policy
With limited exceptions, such as Chapter 1s exposition on Indifference
Curves and Crime, most policy advice in this book has dealt with specic
offences. For example, Chapter 6 discussed strategies to reduce White
Collar crime and Chapter 5 looked at efforts to combat prostitution and
illicit drugs. This is for good reason. In order to catch a criminal, you must
learn to think like them (although not act like them!) and that means exam-
ining policies to deter specic criminal activity.
Modern police techniques owe much to one former master criminal,
Franois-Eugne Vidocq. After being rehabilitated, he established the rst
detective force, the Sret of Paris, consisting at the time of other former
criminals. and his rst-hand knowledge of the underworld and how criminals
thought aided him in foiling crimes. He went undercover to gain information
from informants, introduced the concept of cordoning off a crime scene to
ensure it was undisturbed while looking for physical evidence, invented the
science of ballistics, and began employing sketch artists to render composite
drawings from the recollections of witnesses, an essential task with the grow-
ing urbanization of France to combat the anonymity of the big city. He also
created a card catalog system on which every known criminal in Paris was
listed along with a physical description, a list of crimes, and details of modus
operandi.
Optimal Amount of Crime

Societies decide on the optimal level of crime committed within them.
It certainly cannot be zero, even in a police state. The general rule is we allo-
cate additional resources to ght crime when the marginal benet exceeds the
marginal cost of doing so. Adding more resources results in diminishing
returns while costs increase proportionately. At some nite level of expendi-
ture and at a point short of complete elimination of criminal activity, society
achieves an optimal level of crime from the standpoint of maximizing social
welfare. Other priorities will take center stage, such as civil liberties, as
opposed to expansion of security concerns. Although 9/11 may have shifted
our priorities towards the security side, it did not eliminate our belief in
privacy and due process.
Similarly, individuals engaged in private protection against crime do
not expend unlimited, or even all of their nite, resources in stopping it.
We desire to spend our limited nances on other things rather than devote
them all to the prevention of crime.
We can examine the market for crime prevention and prosecutorial
services, which we will refer to as criminal justice. Although this good is
not as easy to quantify as the number of police ofcers or the amount of
crack cocaine, it can be thought of as an index of a number of factors
including, but not limited to, the number of police, the length of sentenc-
ing, and the amount of technology in forensic science.
This composite good is a normal good. As income goes up, demand for
such services increases. Public perception alters demand for criminal jus-
tice. If crime is of greater concern, demand will shift outward. If it is of
lesser concern, demand will shift inward.
Better technology can reduce the cost of processing a crime scene, caus-
ing a downward shift in the supply function, and increasing demand for its
use (Figure 8.1).
To determine the overall level of funding necessary, we multiply the
price of criminal justice by its quantity. Thus, the light grey plus the dark
grey boxes represent the overall level of expenditure prior to the increase in
technology, while the light grey plus the black box represents the overall level
of expenditure after the increase in technology. An increase in supply will
cause an ambiguous change in overall expenditure. As price declines, each
S Expenditure undertaken regardless of

S* change in price or quantity
Reduction in expenditure due to
Price
lowering of price
Increase in expenditure due to
increase in quantity
D
Quantity
Figure 8.1. Effect of improved technology on criminal justice

expenditures.
PUBLIC POLICY 167
S Expenditure undertaken prior to expansion

of demand for criminal justice services
Expenditure undertaken after expansion
of demand for criminal justice services
Price
D*
D
Quantity
Figure 8.2. Increased demand for criminal justice increases expenditures.
unit of protection costs less but, since quantity demanded rises, expenditure
may increase or decrease depending on which effect dominates.
When demand increases and supply stays constant, expenditure on
criminal justice services unilaterally increases by the amount shown in
black (Figure 8.2). Prior to the increase in demand, only the amount in
grey in expended. After the increase, both the amount in grey and the
amount in black are expended.
Increases in criminal justice spending will not necessarily decrease in
the crime rate, but if it does not, it is unlikely additional resources will be
forthcoming.
We can examine individual parts of the composite good by trying to
equalize the benets we have from the last dollar spent on each type of
activity. The last dollar spent on the police needs to provide the same
reduction in criminal activity as the last dollar spent on the courts and the
last dollar spent on prisons. Indeed, we want to ensure each offsets exactly
one dollars worth of crime.
What would happen if this were not the case? Then we are not at an
optimal level of expenditure. Since the marginal benet from engaging in
any activity falls as more is bought, further expenditure in one area without
a corresponding increase in expenditure elsewhere must correspond to a fall
in the benet achieved on that next dollar. Thus, if, at the margin, an extra
$1 spent on the police results in only a $0.90 reduction in crime, further
increases in the police budget can only result in a fall in the marginal reduc-
tion in crime. Each additional dollar spent actually makes society worse off
and we should actually cut spending on police. It drains $1 in resources but
returns a benet of less than that amount. At the same time, if, at the
margin, an extra $1 spent on prisons results in a $1.10 reduction in crime,

society would be better off increasing its expenditures in this area. This
would continue to be the case until the marginal dollar expended on pris-
ons produced exactly a dollar reduction in crime. When all components of
criminal prevention and prosecution services return an identical return that
at the margin equals the reduction in criminal activity, we will have
achieved an optimal level of crime.
Optimal Punishment Theory

If criminals are rational, what we want to do is make it unprotable for
them to engage in crime. This means exacting a punishment that will
ensure that they are sufciently deterred from engaging in the behavior.
This can take place either with private or public enforcement. Hand out
guns to kids who are picked on at school and pretty soon you have no
bullies. Bullies wont beat up kids with guns. One problem is that you
might alter the behavior of those kids and then they become the bullies.
After all, it is usually the quiet kids who are bullied who end up being the
architects of school massacres. Also the simplest argument could turn into
the Gunght at the OK Corral.
If our goal is to eliminate crime, the solution is obvious: create maximal
penalties. If our society executed people for jaywalking, pretty soon very
few people would be jaywalking. The problem is pretty soon you are
executing a whole lot of people over very minor crimes. Furthermore, by
creating no differentiation between lesser crimes and greater crimes, the
marginal deterrent effect is reduced to zero. If running a stoplight means
execution, what does it matter if you take out a few pedestrians along the
way?
Although this will deter people, it is also far greater than what must
occur. Government has a monopoly in enforcement. It can price discrim-
inate. If it can determine a priori the exact level of punishment required to
deter each individual, it could craft punishments to achieve that reduction.
Thus, if it can practice rst-degree price discrimination, it can achieve
increased penalties at a lower cost to the taxpayer.
Another problem is the law might accidentally punish someone for a
crime they did not commit. Then punishment is not a deterrent at all: the
PUBLIC POLICY 169
innocent person could do nothing to avoid his fate as he was not the one
who committed the crime in the rst place.
Yet another concern is what to do about efcient crimes that raise
social welfare as opposed to lowering it. Think about the cost of speeding
for a moment. There is a slightly increased possibility of a crash or death as
a result. However, getting to a destination faster has its own set of benets.
The doctor rushing to the hospital to perform life-saving surgery may well
be taking a risk that we want to see occur. One possibility is to impose ex
post penalties based on the circumstances of the crime. The standard,
Guilty with explanation that accompanies many in trafc court allows
the court to decide an alternative sentence but this has its own set of issues.
That is because whether the person has a good explanation, they still
imposed a cost on society by raising the probability of a wreck. To ensure
they account for this cost, we estimate the expected value of the damage the
individual would cause and multiply it by the chance they will be caught to
derive an optimal penalty. Thus, if the expected value of the cost to society
is $50 and there is a 1 in 25 chance of catching the speeder, we should
impose a ne of $1,250 to be paid either in ne or an equivalent sentence
to prison based upon the money value of their time (if the person is
judgment-proof in that they lack the money).
For crime in general, one consideration we must make is whether to
engage in nes or prison or even execution. We might prefer nes to jail since
a ne redistributes wealth (from prisoner to the court system) but jail lowers
welfare because the individual who is incarcerated cannot be producing much
for society (and a person who is executed, produces nothing for society). But
then you will have the problem of those individuals who are judgment-proof:
if you dont have the money and the only penalty is a ne, all of a sudden the
cost of murdering someone becomes zero and we get a lot of murders.
There are other issues as well. Not only is punishment costly but so is
the entire process of handling criminal cases and that cost can make it
possible that we might not want to deter all crimes anyway. For example,
suppose that you steal a candy bar. The cost of prosecuting you is going to
be far greater than the cost of the candy bar. So why might we do it? Well,
if we dont prosecute lesser offenses, we might end up with more egregious
ones, according to Kelling and Wilsons Broken Windows1 theory.
Another issue is if we dont stop the theft of candy bars, pretty soon a lot
of people will be stealing them. After all, the government has pretty much
said that it was okay to do it. Of course, then the store owners might all go
and buy guns and alter the calculus again: after all, do you really want to
steal a candy bar if it means that you might get shot? Thus one reason we
police small crimes is to stop not only petty crime but also vigilantism.
Of course, we must consider the fact we do not catch everyone. Thus we
might not punish everyone who steals a candy bar. Let us suppose that the
price of a candy bar is $1. Furthermore, let us suppose that the average
thief values candy bars at $0.35. That would mean that society loses
$0.65 in the transfer from one person to another via theft.
Suppose it costs $100 to apprehend and convict an individual. Now
while that is the marginal cost of capturing and apprehending someone, it
isnt the marginal cost of deterring the crime. What we really want to know
is how much it costs to stop a crime from occurring. For that we need to
know the demand curve for stealing a candy bar. Suppose it is rather at
and, therefore, relatively elastic, looking something as shown in Figure 8.3.
The price paid is the expected cost of punishment. The quantity is the
number of candy bars stolen. The trick is to get the marginal benet from
deterrence for society equal to the marginal cost of deterrence for society.
So what is the cost and benet of deterrence? Well, we have to calculate
that. Let us suppose we capture 1 out of every 1000 individuals who steals
a candy bar. According to our theory, we should initially set the ne at
$250. Suppose there are 800 criminals at that rate. If we decide to employ
more police, we raise the expected cost of punishment to $0.26 from
$0.25 (by capturing 1 out of every 96 individuals and keeping the ne at
$250) and end up reducing the number of thieves by 50 (Figure 8.4).
Price
Quantity
Figure 8.3. Demand for stealing a candy bar.

PUBLIC POLICY 171
$0.26
Price
$0.25
750 800
Quantity
Figure 8.4. Determining marginal benefit of deterrence.
By raising expected cost by $0.01, we reduce the number of thieves by

50. However, with more police on the streets, our costs went up as well.
Suppose it costs us $25 to apprehend and prosecute a criminal. This would
be the marginal cost of deterrence. Now we have to look at how much
society saved from this action. The fact 50 criminals no longer decided to
try to steal the candy bar means they valued the candy bar at between
$0.25 and $0.26. If they had valued it at above $0.26, they still would
have stolen it even if the price rose to $0.26. If they had valued it at below
$0.25, they wouldnt have been in the group of 800 criminals who had
stolen the candy bar at $0.25.
Since the owners of the stores where the candy bars were stolen valued
the candy bars at $1, then net gain to society from preventing these thefts is
about $0.74 to $0.75 for each theft times the 50 thefts that were prevented.
That means that society gained somewhere between $37.00 and $37.50 by
preventing the thefts. This would be the marginal benet from deterrence.
Since the marginal benet to society from deterrence ($37.00 to $37.50)
exceeds the marginal cost of deterrence ($25) to capture and apprehend the
criminals, we should raise the expected cost of punishment. Indeed, we will
continue to raise the expected cost to the criminal until the marginal benet
of deterrence for society equals the marginal cost of deterrence for society.
Four questions may now be asked. First, isnt it a problem the expected
value of the ne is lower than the cost of the candy bar? Second, since each
thief pays for the prosecution of the crime, wouldnt it be better to just
impose the ne on everyone who steals? Third, shouldnt we be deterring
efcient crime as well? Fourth, exactly how did you come up with the
demand curve for crime anyway?
In answering the rst question, we can start by thinking about our eco-
nomic model of crime. Remember people steal because the expected value of
their theft exceeds the expected value of getting caught and punished (after
accounting for their individual valuation of risk). The average thief valued
the candy bar at $0.35, so we can deter her and all those who value the candy
bar at less than $0.35 by setting our punishment at $0.35. If we set it at
$1.00, we deter all theft but at a considerable cost, since monitoring activities
would have to be excessive or we would need disproportionate punishment.
In examining the second question, every time we catch and prosecute
someone, we move resources from another activity. While the prisoner
might pay for the judges, police, and so forth, those individuals are still
engaging in a non-productive activity: they are stopping people from
destroying wealth as opposed to creating wealth. Thus, if society values cre-
ating wealth, it might not want to devote so much to simply preserving it.
In addressing the third question, we are tempted to argue just because a
transfer results in a net benet doesnt mean we should condone unlawful
transfers of wealth. We might argue we should price the ne at $1 or even
higher, to prevent theft by those made better off from trade. However, this
isnt the case. Efcient crime is still punished but it is punished at a rate so
that the transfer benets are negatedyou pay for your crime, just as you
would in a trade, only you do it with a probability (punishment) as
opposed to a certainty (trade). So the most you ever have to set the pun-
ishment at is the value of the good in order to deter crime for all risk-averse
or risk-neutral criminals. After all, if you have a choice between paying
$1 for a candy bar or paying an expected value of $1, you should be indif-
ferent between these two choices if you are risk-neutral. Indeed, because of
moral costs such as a belief that stealing is wrong, the expected cost of
punishment usually must be quite low to most people to steal.
But wait a moment. Why are we counting the damage done to society as
the difference between the cost to the victim and the gain to the criminal?
Shouldnt we negate the criminals gain entirely? Isnt it just morally wrong
to steal? That may be but the optimal punishment theory isnt concerned
with morality or ethics or justice or anything else underlying our system of
jurisprudence. All that matters is efciency. If benets outweigh costs, we
should do it, and we should consider the costs to the criminal just like every-
one else because the criminal is part of society.
PUBLIC POLICY 173
You might want to extract the criminal from society and impose a
higher cost. Yet a criminal is only a criminal when he actually commits
a crime. The person is a criminal when they steal, but if we deter them
from crime, they are not a criminalthey are part of society. There is
another issue. Suppose June steals a $500 TV from an appliance store. June
offers the TV for sale at $350 and Tim steals it from June. Tim values the
TV at $300. We would want to punish both Tim and June for stealing.
If we discount Junes benets from stealing the TV, however, what has
Tim stolen? If you argue we should count the benet for June in one exam-
ple, you have to argue the same in the other example just to be consistent.
Otherwise, theft from individuals who are criminals should go unpunished
(of course, you may think it should go unpunished).
Finally, to come up with a demand curve, we look at how individuals
react to different punishment levels and probabilities of capture. We pro-
duce a demand equation for crime the same way we produce a one for
apples or cars. You never see a demand equation in the real world for those
either, as all you see are points where trades occur. By mapping different
pricing points and quantities demand and with stable preferences, you can
construct a demand schedule for any behavior, including illicit behavior.
Controversies in Public Policy

We will conclude this chapter by looking specically at three public policy
issue: gun control, three strikes laws, and racial discrimination in criminal
justice matters. We will be examining each debate from an economic
standpoint rather than trying to develop theory to answer these questions
since these controversies may best be thought of as having multiple facets
that make denitive answers problematic.
Gun Control
Whenever mass murder hits the news, we have calls for more gun control.
As noted in Chapter 7, gun control will almost certainly reduce
ashpoint killings in the spur of the moment when people reach for the
nearest weapon. However, there is the counterargument that concealed
weapon permits reduce crime because the expected cost for criminals
increases when they might shot by their intended victim.
It is also certainly clear that safe storage laws reduce the likelihood
an innocent child will come across a gun and while playing with it will
accidentally discharge a bullet into another child or adult. Gun control
advocates also like to argue safe storage will reduce the chances of a perpe-
trator using a gun on the homeowner. However, safe storage makes it more
difcult for homeowners to defend themselves. If it takes time to retrieve
the safely stored handgun, what is the point of having it around for
defense? According to Lott,2 the passage of safe storage laws resulted in
9% more rapes and 5.6% more burglaries. It seems that criminals are not
as scared when access to guns is reduced.
The jury is still out on whether gun control will reduce crime. However,
what will not reduce crime is gun registration. Registering guns is a fairly
useless exercise since solving a case where a gun is used because the perpe-
trator conveniently left the gun that was registered to them at the scene for
police to nd is of ridiculously low probability. Either the criminal will
dispose of the gun in some manner, will use an unregistered gun (or one
registered to someone else) or will be found at the scene of the crime with
gun in hand. Spending money on gun registration diverts police resources
away from other criminal enforcement and thus causes crime, rather than
reduces it.
With over 200 million guns in circulation in the United States, it is
unlikely gun control can ever be truly effective. Criminals will always nd a
way to acquire guns, so maybe allowing the rest of us to have them is not
such a bad ideaor at least if we are going to restrict something we might
want to restrict the item consumed when discharging a weapon, the bullet
itself. As comedian Chris Rock 3 jokes:
You dont need no gun control. You know what you need? We
need some bullet control . I think all bullets should cost
$5,000if a bullet costs $5000 thered be no more innocent
bystanders . Every time someone gets shot, people will be like
Dang, he mustve done something. Say they put $50,000 worth
of bullets in [him]. People would think before they killed some-
body if a bullet cost $5,000. Man, I would blow your %$#@
head off, if I could afford it.
PUBLIC POLICY 175
Three Strikes Laws
Recidivism is a recurrent problem in criminal justice. Statistics suggest that

about 40% of all parolees are returned to prison within 3 years.4 Prison is
supposed to rehabilitate but instead it may harden criminals and make
them more likely to continue a life on the other side of the law. Prisoners
can also share techniques to reduce their future subjective probability of
capture.
Those with a lower subjective probability of capture will nd them-
selves more likely to commit crimes. Thus we might want to set a higher
penalty for those convicted multiple times. In addition, the likelihood that
the person was wrongfully convicted multiple times is certainly less than
the likelihood of an initial rst wrongful conviction.
Another reason for harsher penalties for repeat offenders is offenders do
end up with lower costs after the rst felony since most of the resume
damage (the reduction in probability that they will be able to secure a job)
occurs with the initial conviction. Thus, in order to deter further crime,
one might have to raise subsequent sentencing. All of this follows from our
standard marginal analysis of crime.
Furthermore, those penalties may have to be quite stiff in order to
counter the civil death that so many convicts face. For example, felons
in Florida, Kentucky, Virginia, and Iowa face lifetime bans on voting,
while lifetime bans for some felons are found in seven other states. Sex
offenders are publically identied and are prohibited from residing in areas
where children congregate, including school bus stops, which can make it
almost impossible for them to secure accommodations. Many professions
require a clean criminal record for their practitioners, while businesses can
actively discriminate against those with criminal convictions. Therefore,
the opportunity cost of crime is much lower for those previously convicted
than rst-time offenders.
All of these factors play into three strikes laws, which mandate
lengthy prison sentences for repeat offenders and sentence career criminals
to a lifetime behind bars, the proverbial Three Strikes and Youre Out!
mandate.
There are nearly 125,000 prisoners who are at least 55 years old and
over 25,000 who are 65 or older.5 Yet, recidivism is rare past age 50 and
almost nonexistent after age 65, while per prisoner correctional costs for
elderly inmates are three times that of younger prisoners, due predomi-
nantly to medical expenses.6 Releasing old prisoners will transfer some
costs to public assistance programs, such as Medicaid and Supplemental
Social Security but overall state and federal expenditures will decline. The
main reason for not releasing them is a overreaching belief you do the
crime, you serve your time as witnessed by passage of
truth-in-sentencing laws and three strikes penalties. Yet, individuals dis-
count the future quite heavily so the average 30 year old probably is not
thinking about spending his golden years behind bars when he commits
armed robbery.
Perhaps the worst problem of stricter sentencing guidelines is it denies
to judges and prosecutors the exibility to offer plea bargains that can save
taxpayers money. It can also mean once a person commits a felony, there is
less incentive not to commit another. It leads to a graying of the prison
population and reduces incentives for prisoners to be on their best behavior
while in prison. Normally, prisoners earn credits towards early release if
they obey prison rules. They are granted privileges that are for most of us
taken for granted as part of our ordinary lives but the ability to watch tele-
vision or access a library are not rights when you are incarcerated. By man-
dating penal and judicial systems get tough on crime and make inmates
do hard time, we place both the public and correctional ofcers in
increased danger.
Racial Disparities under the Law
Lady Justice, whose statue appears before many courthouses, is often seen
in a blindfold, rendering her verdict in an impartial and objective manner.
However, many commentators argue disparities such as the sentencing
guidelines for crack versus powder cocaine possession that were
100:1 before the Fair Sentencing Act of 2010 are evidence of racial bias
since blacks tend to be found with crack while whites possessed powder.
Wolfgang7 reports on a study of rape convictions from 19451965 in
southern states that found when black men raped white women, they were
18 times more likely to receive a death sentence than any other grouping of
rapists and rape victims. Abrams, Bertrand, and Mullainathan8 nd in
Cook County, Illinois, judges sentence African-Americans to prison more
PUBLIC POLICY 177
often than whites sentenced for the same crimes. Bowers, Steiner, and San-
dys9 show the race of individual jurors, as well as the race of defendant and
victim, infects the capital-sentencing process.
It is not only defendants who seem to be victims of discrimination. If
jurors systematically view the criminal justice system through the lens of
race, criminal defendants might reasonably ask a jury of their peers be com-
posed of individuals of the same race but this will conict with a
jurors right to be seated when that juror is of a different race. Under-
wood10 notes the right of the juror to be seated for a trial is one of equal
protection under the law. When lawyers are allowed to select a jury that
excludes a particular race, they are implicitly arguing the juror cannot be
trusted to be impartial simply because of race. This bias against the ability
of African-Americans to judge fairly is also present in federal attorney appli-
cations for wiretap approval, which, as noted by Miles,11 are far less likely
to be presented to African-American judges.
This points to a potential pitfall that threatens to drive an even greater
wedge between races in this highly charged political environment. On
April 29, 1992, a jury, consisting of 10 whites, 1 Hispanic, and 1 Asian
acquitted four Los Angeles police ofcers of charges of using excessive
force in attempting to arrest black motorist Rodney King. South Central
Los Angeles broke out in riots resulting in the deaths of more than
50 individuals and $1 billion in property losses.12 The following year,
two of the four police ofcers were convicted of violating Kings civil
rights in a separate federal trial where the jury was more racially diverse
with two African-American jurors on it.
While justice may eventually have been served, trying these ofcers on
ancillary charges begs into question as to whether the government was
acceding to the demands of an unruly crowd that demanded blood. Defen-
dants are never the most popular individuals in society but when we refuse
to honor a verdict, no matter how much we disagree, we risk devolving
into vigilantism and driving a stake through the rule of law.
Conclusion
In this book, we have looked at how economics is used to analyze crime, a
subject that would not, at rst, seem to be under the purview of a eld that
predominantly studies legal market interaction. However, tools such as
game theory, general equilibrium theory, and marginal analysis lead us to
conclusions that are quite profound and challenge traditional ideas about
retributive justice.
While no eld can claim a monopoly on the truth, it is equally true the
use of analysis from various elds can signicantly improve public policy.
When sentences are more determinant as prescribed by truth in
sentencing laws, there is less opportunity to reduce costs in the criminal
justice system and we end up incarcerating those who pose little danger to
society. When we try to legislate morality by passing laws against drugs and
prostitution a signicant portion of our society rebels. When we fail to
acknowledge and correct racial disparities in sentencing and jury selection,
we create a two-class system in which an aggrieved group may fail to honor
the verdicts that are rendered regardless of the legal basis that was given for
them. When we insist on proling people based on race, we ignore that
criminals are rational and will take steps to negate our proling. Think
about that the next time you wonder why we dont simply haul all Mus-
lims off for secondary screening at airports and let everyone else through. If
we did that, we would nd it wont take long before the terrorists are pre-
tending to be rabbis.
Economics may not have a monopoly on the truth but it is also true it
can assist us in many ways to understand and effectively reduce social devi-
ancy. That is something we can and should all appreciate.
Notes
Introduction
1. Anderson (1999).
Chapter 1
1. Hull (2000); Corcoran, Pettinicchio & Robbins (2012).
2. Holahan (1998). The exposition follows the example found in this article.
3. Finkelhor & Ormrod (2000).
Chapter 2
1. Nelson (1970; 1974).
2. Stigler & Becker (1977).
3. Becker & Murphy (1988).
4. Becker (1996).
5. This section is derived from the analysis found in Becker (1968).
Chapter 4
1. Coase (1937).
2. Stirling (1990).
Chapter 5
1. Block (2008).
2. Freeman (1996).
3. Vencill & Sadjadi (2001).
Chapter 6
1. Whiteside (1978).
2. For more information on this, see Block (2008).
182 Notes
Chapter 7
1. March (2004).
Chapter 8
1. Kelling and Wilson (1982).
2. Lott (2000).
3. Rock (1999).
4. Pew Center on the States (2011).
5. Human Rights Watch (2012).
6. American Civil Liberties Union (2012).
7. Wolfgang (1974).
8. Abrams, Bertrand, and Mullainathan (2012).
9. Bowers, Steiner, and Sandys (2001, p. 266).
10. Underwood (1992).
11. Miles (2012).
12. Dreier (2003).
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Abrams, D. S., Bertrand, M., & Mullainathan, S. (2012). Do judges vary in their
treatment of race. Journal of Legal Studies 41(2), 347383.
American Civil Liberties Union (2012). At Americas expense: The mass incarcer-
ation of the elderly. New York, NY: American Civil Liberties Union.
Anderson, D. A. (1999). The aggregate burden of crime. Journal of Law and
Economics 42(2, October), 611642.
Bastiat, F. (1995). What is seen and what is unseen. In Selected essays on political econ-
omy. Irvington-on-Hudson, NY: Foundation for Economic Education.
Becker, G. S. (1968). Crime and punishment: An economic approach. Journal
of Political Economy 76, 169217.
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Becker, G. S., & Murphy, K. M. (1988). A theory of rational addiction. Journal of
Political Economy 96(4), 675700.
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of Economics, 108(4), 941964.
Block, W. (2008). Defending the undefendable. Auburn, AL: Ludwig von Mises
Institute.
Bowers, W., Steiner, B. D., & Sandys, M. (2001). Death sentencing in black
and white: An empirical analysis of the role of jurors race and jury racial
composition. Journal of Constitutional Law 3(1), 171274.
Burkey, M. Game theory: Anticipating reactions for winning actions. New York,
NY: Business Expert Press.
Coase, R. (1937). The theory of the rm. Economica 4(16), 386405.
Corcoran, K. E., Pettinicchio, D., & Robbins, B. (2012). Religion and the accept-
ability of white-color crime: A cross-national study. Journal for the Scientic
Study of Religion 51(3), 542567.
Dreier (2003). Americas urban crisis a decade after the Los Angeles riots. National
Civic Review 92(1), 3555.
Finkelhor, D., & Ormrod, R. (2000). Characteristics of crimes against juveniles.
Washington, DC: Department of Justice.
Fiorentini, G., & Peltzman, S. (Eds.) (1995). The economics of organized crime.
Cambridge, UK: Cambridge University Press.
Hoefer, S., & Ariely, D. (1999). Constructing stable preferences: A look into
dimensions of experience and their impact on preference stability. Journal of
Consumer Psychology 8(2), 113139.
Holahan, W. L. (1998). Getting tough on crime: Exercises in unusual indifference
curves. Journal of Economic Education Winter, 1422.
184 REFERENCES
Hull, B. B. (2000). Religion still matters. Journal of Economics 26(2), 3548.

Human Rights Watch (2012). Old behind bars: The aging prison population in the
United States. Washington, DC: Human Rights Watch.
Kelling, G. L., & Wilson, J. Q. (1982, March). Broken windows: The police and
neighborhood safety. Atlantic Monthly: 2938.
Madjd-Sadjadi, Z. (2014). The economics of common and civil law. New York, NY:
Business Expert Press.
March, G. E. (2002). Murder as a business decision, second edition. Lanham, MD:
University Press of America.
. (2004). And, injustice for some: Corrupt exchange and the risk-averse
ofcial. American Review of Political Economy, 2(2), 7798.
Miles, T. J. (2012). Racial disparities in wiretap applications before federal judges.
Journal of Legal Studies 41(2), 419458.
Pew Center on the States (2011). State of recidivism: The revolving door of
Americas prisons. Washington, DC: The Pew Charitable Trusts.
Rock, C. (Writer), & Truesdell, K. (Director). (1999). Bullet control [TV variety
show]. In Prince Paul (Producer), Bigger and blacker. Harlem, NY: HBO.
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Economic Review 67(2), 7690.
Stirling, C. (1990). Octopus: The long reach of the international Sicilian maa.
New York, NY: W. W. Norton.
Underwood, B. D. (1992). Ending racial discrimination in jury selection: Whose
right is it anyway? Columbia Law Review 92(4), 725774.
Whiteside, T. (1978). Computer capers: Tales of electronic thievery, embezzlement
and fraud. New York, NY: Thomas Y. Crowell Company
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Criminology 65(2), 239247.
Index
A arbitrage, 114
Anti-counterfeiting foils, 138 bribery of law enforcement, 108
Arson, 140 cocaine and heroin, 113
competitive market, 111
criminal behavior, 112
B decriminalization, 114
Becker model, 59 Freeman Parameter, 107
Black and gray markets incarceration, 107
apartments, 46 legalization, 114
arbitrage, 49, 50 methadone maintenance therapy,
controlled substances, 42 113
domestic editions, 50 monopolized market, 110
heroin, sale and distribution of, 43 occasional users, 109
housing, 46 opportunity and transaction costs,
illegal markets, 47 114
incarcerating drug users, 43 price discrimination, 111
inefcient legal market, 45 prostitution, 114117
international editions, 48 public policy, 112
legal markets, 47 stricter sentencing, 108
market price, 45 tolerance, 109
pirated/counterfeited products, 50
price discrimination, 48
rent control, 44
E
stolen goods, 51 Economic approach
textbooks, 48 blame society, 3
video games, 47 crime
Budget constraint, 2526 cocaine, 2
Bureaucratic red tape, 89 denition, 1
diplomatic immunity, 2
interracial marriage, 2
C prosecution, 2, 3
Cannabis plant, 19 visa violation, 3
Capital-sentencing process, 177 death penalty, reinstatement of, 1
Client condentiality, 11 indifference curves and crime,
Cocaine, 2 2426
Computer Capers, 147 institutional analysis, 2224
Counterfeiting, 138139 law-abiding citizens, 4
Criminal organizations, 90 rational actor model (see Rational
actor model)
D sociological approach, 4
Defending the Undefendable, 106 3 strikes laws, 1
Drugs supply and demand
addict cards, 112 demand schedule, 13
ancillary criminal activity, 110 equilibrium price, 15
186 INDEX
factors, 16 Grand Theft Auto, 47

income, 1617
number of participants, 19 H
output goods prices, 19
Hashish, 17, 18
preferences, 16
Honda Accords, 10
price schedule, 12
prices of related goods, 1719
production cost, 20 I
prostitutes, 20 Illegal commodities, 9
quantity/quality, anticipated Institutional economics, 22
changes, 19 Insurance fraud, 140
supply schedule, 13
transactions cost, 15 K
Economics of Common and Civil Law, Kidnapping, 71
122
L
F Law-abiding citizens, 4
Fair share, 74
Firearm, 10
Foreign Corrupt Practices Act of M
1977, 79 Marginal utility, 33
Free rider effect, 72 Marijuana, 17, 18
Methadone maintenance therapy,
113
G 1963 Milgram experiment, 23
Game theory Money laundering, 90
credible threat, 7879 Moral compunction, 11
crime report, 7273
criticisms of
coordination problems, 79 N
selshness, 79 Nash Equilibrium, 66
specications, 80 National Health Service, 113
dominant strategy, 66 Neoclassical economics, 23
dynamic games, 7172
economic Sanctions, 81 O
large groups, problem of, 7374 Online piracy, 136138
market mechanisms, 68 Organized crime
Nash Equilibrium, 66 economies of scale and scope, 87
payoff matrix, 65 extralegal justice, 9497
prisoners dilemma, 6870 government-organized crime
reputation, 7071 connection, 8890
sequential vs. simultaneous games monopoly
chess, 74 command-and-control system,
Columns choices, 74, 75 84
incriminating pictures, 78 cooperation, 86
kindly kidnapper, 76 holographic images, 86
subgame perfect equilibrium, 75 illegal goods and services, 83
Going in Style movie, 6 safecracker, 85
INDEX 187
transaction costs, 84 intentional/negligent damage,

word-of-mouth advertising, 84 122
price discrimination, 9194 violations of law, 122
consumer surplus, 91 vandalism, 139140
criminal activity, 93 white collar crime (see White
discounts, large-scale purchases, Collar crime)
92 Property rights, 22
hurdle model, 92 Prostitution
marginal revenue, 93 contractual obligation, 115
membership, 92 demand restraint system, 115
reservation price, 91 human trafcking, 116
prisoners dilemma, 87 opportunity cost, 116
RICO Act, 83 pornography, 115
trust Pseudoephedrine, 19
federal prosecution, 97 Public policy
Hollywood consumption, 97 crime, optimal level of
incentive compatibility, 9899 criminal justice, 166
interlocking organizations, 98 expenditure, 167
market transactions, 97 private protection, 166
turf wars, 83 gun control, 173174
optimal punishment theory
P Broken Windows theory, 169
demand schedule, behavior,
Pareto Optimum, 68
173
Plagiarism, 121
deterrence, marginal benet of,
PlayStation 2, 47
171
Plea bargaining procedure, 68
efcient crimes, 169
Property crimes
rst-degree price discrimination,
arson, 140
168
counterfeiting, 138139
judgment-proof, 169
fenced goods
risk-neutral criminals, 172
burglary, 135
vigilantism, 170
chop shops, 132
racial disparities, 176177
cross-price elasticity of demand,
three strikes laws, 175176
134
Pyromania
demand for security services,
arson, 141
135
res, price of, 143
income elasticity of demand,
labor market, 144
133
production function, 142
legally purchased goods, 134
Robinson Crusoe economy, 141
penalties, 132
triage, 136
general equilibrium theory (see R
Pyromania) Racketeering, Illegal, and Corrupt
online piracy, 136138 Organizations (RICO) Act,
theft (see Theft) 83
torts Rational actor model
crime of plagiarism, 121 decision-making calculus, 6
criminal complaint, 123 economic approach, benets of, 9
188 INDEX
economic approach, limitations of, property crimes and rational

79 offender
implications, 5 apprehension-risk cost, 37
incentives, 5 car theft, 40
marginal analysis, 1112 direct costs, 37
opportunity cost, 911 expansive facilities, 42
present value, 67 extramarket activity, 40
punishment compression, 6 indirect/opportunity costs, 37
rape, 6 legitimate business, 41
utility-maximizing behavior, 6 monetary and psychic benets,
Rational behavior, 8 36
Rational criminal thesis piracy is stealing, 40
addiction prison, 39
advertising, 53 production decision, 41
constructive processing psychic costs, 37, 38
approach, 56 punishment risk, 37
economic approach, 53 risk-neutral, 39
herd mentality, 56 psychological theories, 35
preferences, 55 punishment, 33
reinforcement and tolerance, 54 security features, 34
risk-taking behavior, 56 socioeconomic theories, 35
subutility function, 55 Winners Curse., 5758
black and gray markets (see Black Risk aversion, 37
and gray markets) Robinson Crusoe economy, 141
calculus
criminal activity, 62 S
expected punishment, 58
Safe storage laws, 174
nancially-motivated murder,
Sex crimes, 9
63
Sicilian Maa, 88
formal economy, 60
Social conditioning, 23
mandatory sentence, 59
Stanford Prison Experiment of 1971,
risk-averse individuals, 63
23
risk premium, 61
standard expected utility model,
60 T
subjective expected utility, 59 Theft
von Neumann-Morgenstern demand-side changes, 129131
utility function, 60 direct consent, 123
chemical imbalances, 36 expensive property, 124
counterfeit bill, 34 governments actions, 123
gender, 36 lax security, 124
law of demand, 35 moral distinctions, 124
marginal utility, 33 professional thieves, 125
moral hazard, 32 supply-side changes
murder, 5153 business costs, 126
physiological theories, 35 competition, 127
precautions, 31 cost structure, 128
market price, 127
INDEX 189
perfectly inelastic demand, 129 contract killing services, 157

price appreciation, 130 crimes of passion, 153
self-insure, 126 death penalty, 156
wealth, involuntary transfers of, nancially-motivated killers,
125 155
Tit for tat strategy, 70 handgun control, 154
Internet, 157
U irrationality, 151
mass murderers, 155
Utility maximization model, 32
moral hazard problem, 153
of passion, 151
V penalty, 152
Vandalism, 139140 perverse incentive, 154
Victimization, 70 retributive punishment, 153
Victimless crimes serial killings, 154
adultery, 105 supply and demand functions,
blackmail, 106 155
consumption patterns, 102 transaction costs, 156
drugs (see Drugs) rape, 160161
homosexuality, 103 violence for hire, 158160
market mechanism, 105 von Neumann-Morgenstern utility
moral objections, 105 function, 60, 61
negative externality, 102
potential victimization costs, 101
W
private smoking, 104
White Collar crime
redistributive crimes, 102
Barings Bank, 148
segmented labor markets
computer crimes, 148
day laborers, 117
embezzlement, 147
entrepreneurship, 117
fraud, 145
illegal immigration, 119
hawking, 146
lax law enforcement, 119
identity theft, 148
skilled and unskilled market,
insider trading, 146
118
Ponzi scheme, 146
wage rate, 118
salami technique, 147
slavery and indentured servitude,
securities fraud, 145
103
shoplifting, 147
societal preferences, 104
stock pumping, 146
societys benet schedule, 104
Violent crimes
assault, 158 X
hate-based crime, 162163 Xbox, 47
murder
blackmail, 156 Y
brutalization effect, 157
Yakuza, 89
capital punishment, 157
communication technology,
157
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Chapter 1 What Does Economics Have To Do

Chapter 2 Are Criminals Rational? Gary Beckers

Chapter 3 Game Theory and the Victim/Perpetrator

Chapter 4 Organized Crime .......................................................... 83

Chapter 6 Crimes Against Property...............................................121

Chapter 8 Public Policy ................................................................165

According to the National Association for Shoplifting Prevention,

What Does Economics

Why Study Crime?

Why Use Economics to Study Crime?

Economics does not make moral judgments or argue punishment

them as having criminal tendencies only encourages discrimination and

The Rational Actor Model

implies when one increases punishments for repeat offenders, there is a

FV = PV(1+r)t = $1,000(1+0.1)3 = $1,000(1.1)3

Alternatively, we can solve for present value:

PV = $1,331/(1+0.1)3 = $1,331/(1.1)3 = $1,331/1.331 = $1,000

Limitations of the Economic Approach

Economists do not examine why or how people choose. We look at what

Of course, some individuals would never commit certain crimes under

Benefits of the Economic Approach

Rather than looking at how individuals differ in nature or environment,

violations in connection with falsifying revenue on corporate statements,

Supply and Demand

Economics use graphs to illustrate supply and demand. We begin with

Table 1.1. Quantity Demanded of Crack Cocaine

The supply schedule (Table 1.2) showing the hypothetical quantities

Table 1.2. Quantity Supplied of Crack Cocaine

demanded is $200 and there were 7,500 ounces purchased at that

Table 1.3. Supply and Demand of Crack Cocaine

Still, a picture is worth a thousand words (or a lengthy table). By graph-

Figure 1.1. Supply and demand of crack cocaine.

The price where quantity supplied equals quantity demanded is called

Figure 1.3. Increase in demand.

methamphetamine, which is higher in purity, to powdered methamphet-

Figure 1.4. Decrease in demand.

Supply is affected by the following factors: number of suppliers in a mar-

Figure 1.5. Increase in supply.

Figure 1.6. Decrease in supply.

Similarly, when prostitutes are arrested, supply of prostitutes will

increase result in an upward shift in the supply curve. Better technology or

Figure 1.7. Increase in cost of production.

Figure 1.8. Decrease in cost of production.

in certain circumstances; less able in others. Certainly, the decisions the

Economics in the neoclassical tradition is about doing the best we can

For the Economist: Indifference Curves and Crime

Figure 1.9. Indifference curves between pollution and transportation.

Good behavior Bad behavior

Figure 1.10. Indifference map.

Figure 1.11. Indifference curve for two economic bads.

Figure 1.12. Determining optimal punishment.

Questions for Review

It went up but the percentage of kidnapping victims subsequently mur-

Figure 1.13. Graphical solution for question for review 4.