Chapter 5 Economics of Crime and Its Prevention: How Much Is Too Much? McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.

Key Concepts Opportunity costs Individually consumed goods and services Semicollectively consumed goods and services Externalities in consumption Free-riding Public goods Cost-benefit analysis Marginal social benefit Marginal social cost Equimarginal principle Psychic income Psychic costs

Emotion versus Reason Crime prevention reallocates resources from productive activities How do we prevent crime? Increased budget But: probably better to ensure quick trials, certain incarceration Long mandatory minimum sentences But: releasing repeat offenders to free up space Outlaw drugs But: increase in crime due to increased cost of acquiring drugs

How Much Crime Prevention is Good? Prohibition (1922) Russian anti-alcohol campaign (~1987) Benefits of crime prevention against costs

Questions to Ask What is crime? How should governments prevent crime? What is the optimal level of crime prevention? How do we allocate resources between police, courts, and penal system? What are the overall effects of prohibition? What makes criminals commit crimes?

What is Crime? Immorality: who is there to judge? Illegality Marijuana smoking Alcohol drinking Gambling Adultery Illegality Illegal is often not immoral Burning trash in the streets Littering Spitting in the streets

What Defines Illegal? Offensive to moral standards Murder Theft Rape Consequences of which offender is ignorant Alcohol Cocaine Conducive to violation of public order Traffic rules Causing decreases in welfare Industrial pollution

Classification of Criminal Acts Violent crimes Crimes against persons Murder Rape robbery Crimes against property Fraud Burglary Theft forgery Illegal trafficking Gambling Narcotics prostitution Other crimes Speeding etc

Crime Rate per 100,000 1986-2006 Year Total Violent Crime Property Crime 1980 5950 597 5353 1983 5175 538 4637 1986 5480 617 4863 1989 5741 663 5078 1992 5660 758 4903 1995 5278 685 4593 1998 4619 568 4052 2001 4161 504 3656 2003 4067 476 3591 2004 3983 466 3517 2005 3901 469 3432 2006 3809 474 3335

Difficulties of Measuring Crime Unreported crime ? What is the dollar value of... Human life Drug consumption Alcohol abuse Human trafficking Overspeeding

Opportunity Cost Principle The net economic cost of crime is the value of GDP without crime minus the actual GDP value. Opportunity Costs of Crime = Direct Costs + Net Negative Externalities + Crime Prevention Costs Direct costs Value of destroyed or damaged property Net Negative Externalities = Cost of negative externalities (drugs) – value added of produced drugs What if the value added exceeds the amount of negative externalities? Crime prevention costs Apprehension Correction (prisons, guards) Not in costs Transfers of purchasing power (theft)

Economic Costs of Crime Costs of crime prevention activities are best defined Labor and capital employed in crime prevention increase GDP, which makes crime prevention an economic good Costs of crime are still not measured in a satisfactory fashion Difficult to measure the dollar value of negative externalities Government Level Direct Expenditure ($ Million, 2005) Percent Federal $40,000 23% State and Local $133,883 77% Total $173,883 100%

Different Types of Goods and Services Characteristics of Goods and Services Exclusivity Rivalry Private Goods and Services Semi-private Goods and Services Externalities Government intervention in the case of externalities Public Goods and Services Free-rider problem Government production of public goods

Exclusivity and Rivalry Goods can be classified according to two attributes: whether they are excludable whether they are rival in consumption A good is excludable if the supplier of that good can prevent people who do not pay from consuming it. A good is rival in consumption if consumption of this good by one individual reduces the ability of the others to consume the same good. 15

Characteristics of Goods Rival in consumption Nonrival in consumption Private goods Artificially scarce goods Excludable • Wheat • Pay-per-view movies • Bathroom fixtures • Computer software Figure Caption: Figure 18-1: Four Types of Goods There are four types of goods. The type of a good depends on (1) whether or not it is excludable—whether a producer can prevent someone from consuming it; and (2) whether or not it is rival in consumption—whether it is impossible for the same unit of a good to be consumed by more than one person at the same time. Common resources Public goods Non-excludable • Clean water • Public sanitation • Biodiversity • National defense

Private Goods A good that is both excludable and rival in consumption is a private good. A private good provides direct satisfaction to the consumer, and consumption by the others becomes impossible once the good is consumed (exclusivity) A private good can be shared, but sharing reduces the extent of satisfaction by the consumers Markets are great at allocating resources when it comes to the private goods 17

Semiprivate Goods Any good or service that is not completely rival and/or exclusive is called a semiprivate good or service. Driver’s education course Exclusive since instructor’s time cannot be consumed by two people at the same time: exclusivity Primary consumption benefit goes to the driver: exclusivity Other drivers and pedestrians benefit as well because of more safety on the roads: not quite rival Landscaping, private home No one can jump over the fence and enjoy the swimming pool: exclusivity Everyone can enjoy the beautiful view from outside the fence: not quite exclusive May be rival for the home dwellers, but not really for the outside gazers

Semiprivate Goods and Externalities Semiprivate goods and services can be defined as goods and services with externalities in consumption Positive externalities: landscaping, driver’s education Negative externalities: smoking Government intervention Private markets in general result in a market failure: resources are not allocated efficiently Government intervention may improve on the inefficient allocation

Internalizing an Externality Example Cigarettes are sold at $5 a pack. Smoking reduces life satisfaction by the others by $1 a pack. The government introduces a tax of $1 per pack. In this case this tax is internalizing the externality. Result: consumers will smoke less (law of demand) and thus the market equilibrium level will get closer to the socially optimal one.

Government Intervention in Case of Semiprivate Goods In case of the semiprivate goods, the government intervention is not replacing the market. The cigarettes are still being sold, but the market equilibrium is now corrected by taxes.

Public Goods A good that is neither rival nor excludable is called Tsunami alert system Everyone can benefit from it If your life is saved due to it, it does not mean fewer lives are saved Examples of public goods National defense Crime prevention Space exploration Antipollution measures

Government Intervention and Public Goods Free market most often fails to allocate resources efficiently in case of the public goods. Government intervention in case of the public goods often replaces the market, as opposed to the case of the semiprivate goods.

Why Markets Can Supply Only Private Goods Efficiently Goods that are nonexcludable suffer from the free-rider problem: individuals have no incentive to pay for their own consumption and instead will take a “free ride” on anyone who does pay. Vigilante Groups in the Old West Horse rustling a problem Cattle ranchers band together in vigilante groups to catch and hang the rustlers, which makes rustling extremely costly Vigilante groups have maintenance costs No one single rancher can be excluded from the benefits provided by vigilantes Every one single rancher is free to withdraw support for the vigilantes and become a free rider The free-riding problem reduces the quantity and quality of vigilante services because of their non-excludability 24

Market-Oriented and Command Systems, and Public Goods Public goods must be provided by the government because the private market “won’t pay” for their production costs due to the free-rider problem The government can coerce private individuals to pay these costs by imposing taxes, which is why the government is most likely to provide the public good efficiently Command systems: the governments provide ALL kinds of goods: public, semiprivate, and public Market-oriented systems: the governments mostly intervene in the provision of public, but not so much of the private goods.

The Optimal Level of Crime Prevention Cost-benefit analysis is a technique for determining the optimal level of economic activity by comparing costs and benefits of the activity As long as benefits outweigh the costs the activity should be undertaken The optimal level is defined as the one for which marginal benefits are equal to marginal costs

The Optimal Level of Crime Prevention Cost-Benefit Analysis of Crime Prevention 1 2 3 4 5 6 Units of Crime Prevention per Year Total Benefit to Society Marginal Social Benefit Total Cost of Society Marginal Social Cost Net Benefit to Society -- 200 60 140 380 180 120 260 540 160 360 680 240 440 800 300 500 900 100 7 980 80 420 560 8 1040 480 9 1080 40 10 1110 20 600

Crime Prevention The Government should follow the following rules in dealing with crime prevention: Increase crime prevention if associated marginal benefits exceed marginal costs Spend less on crime prevention if marginal benefits are below marginal costs Do not aim at zero crime rates Optimal crime prevention occurs at the level of spending where marginal benefits of crime prevention are equal to marginal costs

Allocation of Crime Prevention Budget How much should be spent on police versus courts, for example? Equimarginal principle: an efficient allocation of a budget exists when the last dollar spent on any one facet of the budget yields the same marginal social benefit as the last dollar spent on any other facet Transfers of budget in case the equimarginal principle does not hold

Allocation of the Crime Prevention Budget Equimarginal Principle

Example: Equimarginal Principle Taking $1 away from police works brings about more crime resulting in a 75 cents decrease in GDP Give this $1 to the court system that deters crime so that GDP grows by $3 Society’s net gain is $2.25, so it makes sense to take $1 away from the police and give it to the courts Keep on reshuffling the crime prevention budget until marginal benefits in police, court, and correction activities are equalized—this will be your optimal budget allocation

Alcohol’s Legal Status Eighteenth Amendment to the US Constitution: the Era of Prohibition, 1920 Twenty-first Amendment: repeal of the Prohibition, 1933 Effects of the Prohibition: Rise in murder rate Rise in assaults with firearms 1933 (last year of Prohibition): 12,124 homicides, 7,863 assaults with firearms 1941: decline in these rates to (respectively) 8,048 and 4,525 Should we ban any goods and services at all?

Legalize Drugs? Cons More crime Unexpected consequences Pros Drug-related crime is not caused by drugs per se, rather by their illegal status Illegality results in lack of information about drugs’ effects, hence unexpected consequences

Changing the Legal Status of Goods and Services Price per ounce D1 Modest increase in demand: easy to obtain even if illegal S2 P1 Supply shock is substantial since legalization greatly reduces production costs P2 Click 1: D2 Click 2: S2 Click 3: grid lines at new equilibrium S1 D1 M1 M2 Marijuana (millions of ounces per year)

Effects of Legalization Equilibrium: Dramatic fall in price Great increase in the quantity supplied Health Effects: Quality of marijuana increases, which reduces health risks Effects on Crime: Poor users less likely to rob and mug for money to buy marijuana Fewer criminal cases since illegal acts in the past (i.e. production) are now legal Effects on Efficiency: More GDP can be produced with the same resources since marijuana-related crime prevention activities are now redundant Should we legalize hard drugs? Adding addiction completely invalidates this analysis, so the answer then is NO.

Causes of Criminal Activity Emotional causes Economic reasons Psychic reasons

Economic Reasons for Crime Pursuit of profit However: most street corner drug dealers earn much less compared to blue-collar jobs Present value of expected income once on top of the chain

Revenue (PxQ) + Psychic Income – Economic Income Economic Profit = Revenue (PxQ) + Psychic Income – Opportunity Costs Opportunity costs Explicit Building rental and utility fees Fertilizers and pesticides, seeds Implicit Alternative income foregone Cost of getting caught Loss of social standing (psychic costs)

Marijuana in Appalachia A depressed region in the Eastern US Plagued by poverty for many years Difficult to get a job that pays even a minimum legal standard Low opportunity costs of an illegal job in terms of foregone legal income Marijuana growing is widespread