Drug distribution is handled much like any franchised business. A central gang acts as the wholesaler. Individual gangs are the distributors. They pay a flat franchise fee to the central gang for the right to sell drugs in a particular territory.

A drug gang makes about 80 percent gross profit (calculated as the revenues minus the cost of the drugs sold). However, they then have operating expenses such as the wages paid to officers and pushers, weapons, the franchise fee (called a tribute), mercenary fighters, and funeral expenses. These expenses can reduce the net profit to small levels, although other gang activities such as extortion can offset this. If there is a gang war, fewer drugs are sold, and wage costs fall, but the cost of weapons, mercenaries, and funerals rise; overall, costs may decrease slightly, while revenues may decline significantly, leading to losses.

1. What are the defining assumptions or characteristics of a monopoly? Given your answer, are there area monopolies in the market for illegal drugs? Explain. What factors create and preserve the monopoly?

2. Assume that there are area monopolies in the illegal drug market.
a) For one such monopoly, draw the marginal and average total cost curves, the demand curve and the marginal revenue curve. Show the profit-maximizing equilibrium price and quantity of drugs. Shade in the area representing profit.
b) How do you explain the amount of profit in the illegal drug market? Refer to your diagram.