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Reader Question: What’s Up With The Opium Market?

September 4th, 2009 · 9 Comments
Econ 101 · Incentives · Reader Questions

A Facebook friend posted a link on my wall along with the question “Can someone with an econ degree explain this story?” The link is to an article from the Washington Post with the headline Afghan opium crop down, prices plummet: U.N. I was, in fact intrigued, because the article seemed like it was describing the following decrease in supply:

As usual, a few points:

  • Demand for opium, or how much opium people are ready, willing and able to purchase depends on a number of things. One of those things is price- as the price of opium goes down, all else being equal, people want mose opium.
  • Supply of opium, or how much opium firms want to produce, also depends on a number of things including price. As the price that producers can get for their opium goes up, all else being equal, producers want to grow more opium. In this way, prices act as a way for resources to shift to their most profitable uses.
  • The market for opium tends toward an equilibrium price where the demand for opium is equal to the supply of opium. This is because if the price is too low there is a shortage, and shortages drive up prices. Conversely, if the price is too high then there is a surplus, which basicallly causes producers to put their opium on sale. Graphically, this equilibrium is where the demand and supply curves intersect.
  • When the headline said that the opium crop was down, I had taken this to mean that some non-price factor (bad weather, increased picking costs, whatever) had caused the supply to decrease at every price. Hence I drew the dotted line for the new supply curve in the diagram above.
  • This situation would result in a lower quantity of opium sold along with a higher price for opium.

This is a lovely story, but it is not consistent with the part of the headline that says that prices went down. Hm. I suppose it would help to read the actual article. The article starts as follows:

Opium cultivation in Afghanistan fell by 22 percent this year as prices for the drug tumbled causing farmers to switch to other crops, the United Nations said on Wednesday.

Oh. From what I can now tell, my confusion stems from the fact that the headline is somewhat misleading- it implies that the lower supply leads to the higher prices rather than the other way around. So what is the real story?

There we go. It must be the case that something other than price is moving around the demand for opium (I can blame lower income due to the recession, for example). The decreased demand then means that firms can’t get as high of a price for opium as they used to, and so growing opium becomes less attractive. If making a product becomes less attractive, you’re going to make less of it and shift some resources to doing something better, right?

It’s kind of interesting that even the market for an illegal (at least in most places) product in a developing part of the world exhibits cleanly the implications of the economic supply and demand model. If you aren’t yet convinced that economics is everywhere, consider the following evidence:

A few months back, The Daily Show featured Husain Haqqani, the Pakistani Ambassador to the U.S. He pointed out that one of the problems in fighting the Taliban is that the Taliban, because of its involvement in the opium trade, has more monetary resources to take care of people than do the governments of countries such as Pakistan or Afghanistan. In other words, the Taliban is paying people to join, and the people are responding to a financial incentive. (Economic Principle #4: People respond to incentives.) Sad, but understandable to a degree. (It’s shockingly hard to get people to act against their own economic self-interests, so probably worth thinking about how to shift the incentives in the “right” direction.) Here’s the video:

The Daily Show With Jon Stewart Mon – Thurs 11p / 10c
Husain Haqqani
Daily Show
Full Episodes
Political Humor Healthcare Protests

Quote of the day: “The Taliban are a nuisance, just as some of your guests are.” Hee. Some more choice dialogue:

Jon: “Why are they going to work for the Taliban and not for the Pakistani police?”
HH: “…the Taliban managed to be able to raise funds to pay their foot soldiers more than what the Afghan national army pays them…”
Jon: “How does the Taliban have more money to pay them than the Afghan or Pakistani government?”
HH: “…it is definitely opium.”

Ah, it all comes full circle now. I suppose it’s then not surprising that the WaPo article refers to the decline in opium production as a “rare bit of good news.”

Tags: Econ 101 · Incentives · Reader Questions

9 responses so far ↓

  • 1 Rev. Pfloyd // Sep 4, 2009 at 4:45 pm

    Excellent read. Now if I could only talk our elected officials into pursuing similar ways of funding our military projects. Hmmmm. . . .

  • 2 econgirl // Sep 4, 2009 at 4:49 pm

    “Picture yourself in a boat on a river, with tangerine trees and marmalade skies….”

    Oh, uh…wait, what were we talking about again? I must’ve gotten distracted… 🙂

  • 3 W Chang // Sep 4, 2009 at 4:57 pm

    That sorta got me thinking before I realized I had other things to do … How legalization of marijuana shift the S+D curves? My first instinct would be ..

    1) Shift(increase) in demand curve (oh it’s legal now? hook me up!)
    2) Temporary increase in (equilibrium) price
    3) Shift in supply curve? (I would imagine that big corps, ahem Philip Morris, would want in on the action)

    Naturally, taxation of it would come into play.
    The complexities I haven’t bothered to dig to deep into include externalities (social impact) and price sensitivity of various consumer segments (I would assume college kids can spend only so much on weed 😛 )

    I’d be very curious to see how a scenario could play out if marijuana were legalized. Production definitely goes up, but pricing would seem to be a bit trickier (especially considering that there would likely be different qualities/strains of marijuana)

  • 4 Rev. Pfloyd // Sep 4, 2009 at 5:33 pm

    The other thing to take into account would be that growing your own is still fairly easy but with it being legalized I think there would be a market saturation, especially if taxes got involved. I think there would still be plenty of underground markets involved and it’d certainly make local farmer’s markets more interesting.

    Truth be told, unless corporations can make a product that just can’t be easily reproduced by home-growers (or insanely cheaper than growing it at home in terms of opportunity cost) I’m not sure there would be a huge government-revenue benefit to legalizing it.

  • 5 hh // Sep 4, 2009 at 6:00 pm

    ok, so now that prices have plummeted, the army should be able to make better offers to the coin-operated Taliban troops and win the war, right?

    ps – not the same hh 😉

  • 6 Surender // Sep 5, 2009 at 7:33 am

    Great!! Nice explanation!!

  • 7 PG // Sep 5, 2009 at 8:54 am

    Why not to employ those unmanned drone aircrafts to flush out poisons on the taliban opium cultivation first and then handle the talibans later?

  • 8 jimbo slice // Sep 8, 2009 at 1:58 pm

    jimbo bak fa rnd 2 yaall cant stand my ish! yo, surrender! give up son, give up!!!

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