Written by Dhruvi Dedhia
In most contexts, an excess of anything is undesirable. One of the most debilitating forms of excess, addiction, has long been studied from an economic perspective to the extent that several economic models of addiction have been proposed over the years. Defined as a “state of psychological and/or physical dependence on the use of drugs or other substances, such as alcohol, or on activities or behaviors, such as sex, exercise, and gambling” (American Psychological Association, 2021), much economic research focuses on addiction as substance abuse of alcohol and tobacco products.
Given that addiction is essentially rooted in psychological concepts, behavioral economics is often used as a framework to study substance abuse. Research in this avenue has theorized that substance abuse is directly related to the availability and lack of impediments (e.g. price) on access to the substance, and inversely related to the availability and lack of restraints on access to substance-free activities (Murphy and Dennhardt, 2016). The law of diminishing
marginal utility states that the satisfaction gained from consuming each additional unit of a good decreases, but behavioral economics critiques this idea when it comes to addiction: bounded self-control, the idea that individuals have a finite capacity to resist instant gratification and make choices that are in line with long-term goals, captures the basic nature of addiction and substance abuse.
Beyond such behavioral links, substance abuse has measurable economic impacts that extend beyond an individual level. In base terms, the “annual economic impact of substance misuse is estimated to be $249 billion for alcohol misuse and $193 billion for illicit drug use” (Addiction and Substance Misuse Reports and Publications, 2019). These numbers essentially represent a social cost. While substance abuse evidently has personal costs, such as deteriorating health, familial conflict, increased expenses, etc., consuming such products also has spillover negative effects on third parties not part of the “transaction” (of supplying/demanding the good)—this is a negative consumption externality. Negative consumption externalities occur when the marginal private (personal) benefit of consuming something is greater than the marginal social benefit. That is, society at large would be better off if less of the good were consumed. This “excess consumption” creates a deadweight loss, or “a cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium” (Tuovila, 2020). These “costs” to societies could be understood as addiction causing socially undesirable behaviors, inability to remain in the labor force, lack of participation in the economy, consequences of drunk driving, etc.
A common way to address negative consumption externalities—and indeed, a common restriction on alcohol and tobacco product sales—is government intervention through indirect taxation. The average state tax on cigarettes is about $1.93 (US State and Local Tobacco Taxes,
2014), while the peak federal tax rate on alcohol is $13.50 for distilled spirits per proof gallon (Congressional Budget Office, 2022). Essentially, as taxes are paid to the government by producers, they work to increase the cost and therefore decrease the supply of a good. This would, in turn, reduce the quantity consumed, thus shifting the market equilibrium to the “socially optimal” level and erasing the externality.
Although many studies show that increasing taxes and therefore prices are effective in reducing substance consumption (Elder et al., 2010), such policies must take into account the price elasticity of demand (PED)—i.e. the relative proportion by which quantity demanded changes in response to a change in price, calculated as (% change in demand)/(% change in price). Based on the mathematical relationship, products with |PED| < 1 are considered price inelastic, as the demand for these goods changes proportionally less in answer to price changes. Several studies find inelastic PED estimates for cigarettes, such as -0.4 (0.4) (Kohler et al., 2023). Similarly, estimates for alcohol include values—based on the type/price of alcohol—from 0.019–0.06 (Goryakin et al., 2014). This suggests that for price increases to effectively diminish consumption, tax increases must be proportionately higher.
The low PED value also has implications for the tax revenue (as well as firm revenue) earned on the sale of tobacco products and alcohol. Because increasing the price causes a comparatively lower decrease in quantity demanded, governments stand to earn from taxing such goods, and firms could potentially increase profits by raising prices.
A Game Theory Model
Based on the outcomes discussed above, we now look at a hypothetical game theoretical framework of addiction. The “players” of this game are individuals suffering from an addiction
(called user), and their “future” or substance-free selves (non-user). Although game theory has been developed as a framework considering the actions of individuals, it could similarly be applied to “transient” selves (Parfit, 1984)—in this context, each “self” is an individual, rational player. Each player has two strategies—use, or not use. For user, the benefit of using is the pleasure/satisfaction of indulging, while the cost is continued addiction and all its subsequent consequences, quantified. For non-user, the benefit is again the gratification of indulging, but this time perhaps to a greater extent given the length of abstinence; the cost would similarly also be greater, as using would not only imply the general costs of substance abuse but also the added potential loss of any progress made during abstinence. For user, the benefit of not using includes better health, potentially rebuilding losses incurred during use (e.g. personal conflicts, job loss, etc.), and general improvement of long-term prospects; the costs include temptation, and withdrawal symptoms (which are often physical as well as mental). For non-user, the benefit of not using is the continued credibility of sobriety, as well as the continued progress of personal advancement made during recovery (family ties, health, productivity, etc.); the cost is temptation, and possibly withdrawal symptoms, but both to a relatively lesser extent.
Thus, based on the qualitative outcomes for each player, it appears that for user, costs for using are relatively higher than benefits, i.e. a negative payoff, while for not using, benefits are relatively higher than costs, i.e. a positive payoff. Similarly, for non-user, the costs for using are relatively higher than the benefits (perhaps more so than user, given the rehabilitation progress, but this may be subjective), i.e. a negative payoff, while benefits are relatively higher than costs for not using, i.e. a positive payoff. Of course, applying these ideas and payoffs to a singular scenario or “one” moment might not seem logical (e.g. “just one more drink tonight” may not
seem like such a high cost)—however, these patterns become more evident when viewing consumption (addictive substances) and recovery through a long-term lens perspective.
A basic game theoretical framework thus suggests that recovery is indeed possible; however, in real life, we often do not behave as the completely rational players game theory assumes us to be—a study showed that nearly two-thirds of the Americans surveyed claimed their lives had been affected by addiction (USNEWS.com, 2023). The economic implications of addiction are vast and, in some cases, devastating on not only economic but also humane levels.
References
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Elder, R. W., Lawrence, B., Ferguson, A., Naimi, T. S., Brewer, R. D., Chattopadhyay, S. K., Toomey, T. L., & Fielding, J. E. (2010). The Effectiveness of Tax Policy Interventions for Reducing Excessive Alcohol Consumption and Related Harms. American Journal of Preventive Medicine, 38(2), 217–229. https://doi.org/10.1016/j.amepre.2009.11.005
Goryakin, Y., Roberts, B., & McKee, M. (2014). Price elasticities of alcohol demand: evidence from Russia. The European Journal of Health Economics, 16(2), 185–199. https://doi.org/10.1007/s10198-014-0565-9
Increase All Taxes on Alcoholic Beverages to $16 per Proof Gallon and Index Them for Inflation | Congressional Budget Office. (2022). Www.cbo.gov.
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Murphy, J. G., & Dennhardt, A. A. (2016). The behavioral economics of young adult substance abuse. Preventive Medicine, 92, 24–30. https://doi.org/10.1016/j.ypmed.2016.04.022
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Parfit, D. (1984). Reasons and persons. Oxford University Press.
Tuovila, A. (2020, June 30). Deadweight Loss Definition. Investopedia.
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Reinberg, S. (2023, August 15). Two-thirds of Americans Say Their Lives Have Been Affected By Addiction. USNEWS.com.
https://www.usnews.com/news/health-news/articles/2023-08-15/two-thirds-of-americans say-their-lives-have-been-affected-by-addiction-poll