The Economics of Addiction

• A. Addicts never consider future consequences of their consumption
• B. Addicts have forward-looking preferences and respond to future price changes, even while consuming more over time ✓
• C. Addicts consume goods only when prices are at their lowest
• D. Addicts have no stable preferences and change their tastes randomly

Why: Becker and Murphy's rational addiction model assumes individuals are forward-looking and make consistent choices given their preferences. Past consumption increases current consumption (addiction), but the person still weighs future costs and benefits, so they respond to anticipated price changes.

• A. Substitution effect
• B. Diminishing marginal returns
• C. Reinforcement or addictive capital ✓
• D. Opportunity cost

Why: Addictive capital (or reinforcement) means that past consumption raises the satisfaction derived from current consumption. This is the defining feature that makes a good 'addictive' in economic models, distinguishing it from ordinary goods where past consumption does not affect current utility.

• A. Consumption rises in both the short and long run
• B. Consumption falls more in the long run than in the short run, because demand for addictive goods is more elastic over time ✓
• C. Consumption falls more in the short run than in the long run, because addictive goods are less price-sensitive over time
• D. Consumption is unaffected by price in both periods

Why: Demand for addictive goods tends to be inelastic in the short run because habits and dependence limit responsiveness. Over the long run, people have more time to adjust, reduce consumption, find substitutes, and the cumulative effect of reduced habit formation lowers consumption more substantially.

• A. A benefit that spills over to people who did not choose to consume the substance
• B. A cost imposed on third parties who did not choose the consumption, such as healthcare costs or secondhand harm ✓
• C. A price discount offered to consumers who purchase in bulk
• D. A government subsidy paid to producers of addictive goods

Why: A negative externality is a cost borne by people outside the transaction. For addictive goods, examples include public healthcare spending, secondhand smoke, drunk-driving accidents, and lost productivity, which can justify policy interventions like taxes.

• A. Because taxes always make consumers happier
• B. Because addicts may underweight future harms, and externalities impose costs on others not reflected in the price ✓
• C. Because taxes eliminate all demand for addictive goods
• D. Because rational consumers always prefer to pay higher prices

Why: Even if addiction is rational in the Becker-Murphy sense, consumers may still misjudge long-term harms or fail to account for costs their consumption imposes on others. A tax can correct these market failures by aligning private prices with social costs.

• A. Rationally addicted consumers ignore future prices when making current decisions
• B. Current consumption depends positively on past consumption, so past use raises the marginal utility of present use ✓
• C. Rationally addicted consumers have no budget constraint
• D. Rationally addicted consumers consume only when prices fall to zero

Why: The core feature of rational addiction is habit formation or complementarity over time: past consumption increases the marginal utility of current consumption. Addiction is treated as forward-looking and consistent with rational choice, not as irrationality.

• A. Temporary price increases have no effect on consumption at all
• B. A permanent increase raises the full stream of expected future costs, reducing the incentive to build up the consumption stock that drives future demand ✓
• C. Permanent price increases make consumers forget their addiction
• D. Temporary price increases always cause consumers to switch to a different addictive good

Why: Because current consumption affects future utility through the habit stock, forward-looking consumers weigh the entire future price path. A permanent increase lowers the long-run return to addictive consumption, so the effect on steady-state consumption is larger than for a transitory change.

• A. Demand for addictive goods is perfectly inelastic in the long run
• B. Long-run price elasticity of demand for addictive goods exceeds short-run elasticity ✓
• C. Addicted consumers never respond to anticipated future price changes
• D. Consumption of addictive goods is independent of income

Why: Rational addiction predicts that long-run elasticities are larger than short-run ones, because consumers adjust their accumulated consumption stock over time in response to sustained price changes. Empirical studies of cigarettes and alcohol have tested this prediction.

• A. Consumption must remain constant over the lifetime, or else the model fails
• B. Addictive consumption is reinforcing, so the model must ensure consumption paths do not diverge without bound, typically via a discounting or depreciation condition ✓
• C. Prices must be fixed by government regulation
• D. Consumers must have identical preferences to one another

Why: Because past consumption raises future marginal utility, addiction can cause explosive dynamics. Stability conditions, often involving a discount rate and a depreciation rate of the habit stock, ensure that optimal consumption converges to a steady state and the model yields meaningful predictions.

• A. Reduce consumption immediately and permanently, before the increase
• B. Increase current consumption, partly to build up a stock before prices rise ✓
• C. Quit entirely regardless of the price path
• D. Ignore the price change because addicts are myopic

Why: Forward-looking consumers exploit the complementarity between past and present consumption. Anticipating higher future prices, they may 'stock up' by consuming more now, since the habit stock they build will be less costly to sustain later in the expensive period. This is a distinctive prediction of the theory.

• A. The total revenue a seller earns from a product
• B. The responsiveness of quantity demanded to a change in price ✓
• C. The government tax rate applied to a good
• D. The difference between supply and demand at equilibrium

Why: Price elasticity of demand measures how much the quantity demanded changes in response to a percentage change in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price.

• A. Goods that consumers buy much less of when prices rise
• B. Goods that have many close substitutes
• C. Goods that consumers buy roughly the same amount of even when prices rise ✓
• D. Goods that are always luxury items

Why: Inelastic demand means quantity demanded changes proportionally less than price. Consumers keep buying roughly the same amount despite price increases, as is often the case for necessities and addictive substances.

• A. Because addicted users have few alternatives and their consumption is driven by dependence rather than price ✓
• B. Because these products are always cheap to produce
• C. Because governments never allow prices to change
• D. Because consumers ignore prices entirely for all goods

Why: Addiction makes consumption less responsive to price in the short run, since users experience strong cravings and withdrawal. This is why a price increase may reduce consumption only modestly, though long-run elasticity is typically larger.

• A. 0.4 ✓
• B. 2.5
• C. 4.0
• D. 10.0

Why: Elasticity equals the percentage change in quantity divided by the percentage change in price: 4% / 10% = 0.4. Since 0.4 is less than 1, demand is inelastic.

• A. It becomes more elastic in the long run as consumers have more time to reduce use or find substitutes ✓
• B. It becomes perfectly inelastic in the long run regardless of circumstances
• C. It becomes negative, meaning higher prices increase consumption
• D. It remains exactly the same at all time horizons

Why: In the short run, dependence limits how much people can respond to price changes. Over longer periods, consumers can quit, cut back gradually, or switch to substitutes, so demand tends to become more elastic.

• A. They must pay higher taxes to government agencies
• B. They cannot enforce contracts through courts and must bear risks of arrest, seizure, and violence
• C. Their products require more raw materials per unit
• D. Consumers demand larger quantities at lower prices

• A. Producers deliberately restrict supply to earn monopoly profits
• B. Prices reflect risk premiums, distribution costs, and enforcement-related expenses along the supply chain
• C. Government subsidies inflate the cost of production
• D. Drugs contain expensive packaging and branding

• A. Prices fall because fewer buyers can afford the drug
• B. Prices rise because reduced supply shifts the supply curve leftward
• C. Prices remain unchanged because demand is perfectly inelastic
• D. Prices fall because sellers compete more aggressively to attract customers

• A. Consumers have no alternative goods available to them
• B. Addiction reduces sensitivity to price changes, so users keep buying even when prices rise
• C. Drugs are cheap compared to household income
• D. Governments set fixed quantity limits on purchases

• A. Drug users inflate their consumption when prices drop
• B. Enforcement in one area or on one drug can push production or trafficking to other regions or substitute substances
• C. Profits from drug sales are typically reinvested into legal businesses
• D. Drug prices rise steadily over time regardless of enforcement

• A. A cost or benefit experienced only by the person who makes a decision
• B. A cost or benefit that falls on third parties who did not choose the activity ✓
• C. A fixed price set by government regulation
• D. The total amount of money spent on a product in a market

Why: An externality is a spillover effect of an economic activity on people outside the transaction, such as costs or benefits imposed on bystanders. Addiction can generate negative externalities like healthcare costs and crime borne by society.

• A. A user's improved mood after using a substance
• B. Family members experiencing financial hardship and emotional stress due to a relative's addiction ✓
• C. The user's decision to purchase a product at a lower price
• D. Increased sales revenue for a retailer selling the substance

Why: Family members who bear financial and emotional costs they did not choose represent a negative externality. The user's private enjoyment or retailer revenue does not capture these spillover harms.

• A. Because addicted individuals always earn more than non-addicted individuals
• B. Because public healthcare systems, law enforcement, and social services often absorb costs caused by addiction ✓
• C. Because addiction has no impact on productivity or employment
• D. Because governments are legally required to pay all private debts of citizens

Why: Public systems such as emergency care, policing, incarceration, and social support programs frequently pay for consequences of addiction, spreading costs across taxpayers who did not make the consumption decision.

• A. Money the government collects in taxes from substance sales
• B. Reduced output and earnings from work missed or performed poorly due to addiction ✓
• C. The increase in factory output during periods of high demand
• D. Savings individuals accumulate by avoiding unnecessary purchases

Why: Lost productivity captures the economic value of work not performed or performed below capacity because of addiction, including absenteeism, reduced efficiency, and early departure from the labor force.

• A. Eliminating all public health programs to lower government spending
• B. Taxing addictive goods so that the price better reflects the social costs they generate ✓
• C. Subsidizing the production of addictive goods to lower prices
• D. Ignoring social costs because individuals are assumed to bear all consequences

Why: Corrective taxes aim to internalize externalities by raising the private price toward the full social cost, discouraging consumption that imposes harm on others. Subsidies or ignoring costs would worsen the market failure.

• A. Raise revenue only, with no effect on consumption
• B. Raise the price of harmful goods such as tobacco or alcohol to reduce consumption and generate revenue
• C. Subsidize producers of addictive goods to stabilize markets
• D. Eliminate all demand for the taxed product through prohibition

• A. Because addictive goods are always produced at a loss
• B. Because consumers may not fully account for future health costs or may have impaired decision-making, leading to overconsumption relative to what they would prefer on reflection
• C. Because addictive goods have no price elasticity of demand
• D. Because governments are legally required to ban all goods with any risk

• A. A public health warning label on cigarette packages
• B. Restrictions on the minimum legal purchasing age
• C. Limits on the number of licensed retail outlets selling alcohol
• D. A mandatory school education campaign about drug risks

• A. How much revenue the government will keep after administrative costs
• B. How responsive quantity demanded is to price changes, indicating how much consumption falls when the tax raises prices
• C. How many people will become addicted in the future
• D. The total profit margin of producers in the industry

• A. Low-income consumers are exempt from all consumption taxes
• B. Low-income households often spend a larger share of income on addictive goods, so a tax takes a bigger proportion of their budget
• C. Low-income consumers always pay zero price for addictive goods
• D. Sin taxes are only levied on luxury goods consumed by the wealthy

• A. Treatment costs are always higher than any benefits, so offsetting costs are needed to justify funding
• B. Addiction imposes costs on society beyond the individual, so the full benefits of treatment extend to reduced external harms ✓
• C. Government agencies are legally required to count only avoided costs and never direct expenditures
• D. Avoided costs are measured in money, while treatment outcomes are measured only in health units

Why: Addiction generates externalities such as crime, healthcare burden, and lost productivity borne by others. A complete evaluation of treatment must count these avoided external costs as benefits, not just the individual's improved outcomes.

• A. They eliminate demand for drugs entirely by making drug use socially unacceptable
• B. They lower the cost of illegal drugs, reducing overall drug market revenues
• C. They can reduce infection and overdose costs at relatively low program expense, yielding high benefit-to-cost ratios ✓
• D. They increase tax revenue by legalizing substances previously under prohibition

Why: Evidence from many evaluations suggests needle exchange and similar programs prevent HIV and hepatitis C infections, which are very costly to treat, so modest program costs can produce large savings and favorable cost-effectiveness ratios.

• A. It guarantees that participants will not relapse during the study period
• B. Random assignment helps ensure that differences in outcomes are attributable to the treatment rather than pre-existing differences between groups ✓
• C. It is always cheaper and faster than observational studies
• D. It removes the need to measure outcomes after the study ends

Why: Random assignment balances observed and unobserved characteristics across groups in expectation, allowing researchers to attribute outcome differences to the intervention rather than selection effects, which are common in observational policy evaluations.

• A. Moral hazard
• B. Adverse selection
• C. Take-up rate gap ✓
• D. Diminishing marginal utility

Why: Take-up rate gap refers to the difference between eligible individuals and those who actually enroll or complete a program. Lower-than-expected take-up reduces realized benefits and must be considered in policy cost-effectiveness evaluations.

• A. Random assignment of individuals to treatment and control groups by a researcher
• B. Natural or policy-driven variation, such as states adopting a program at different times, to compare outcomes ✓
• C. Surveys asking participants whether they believe the policy worked
• D. Only qualitative interviews with policymakers

Why: Quasi-experimental designs exploit naturally occurring or policy-induced variation, such as staggered state adoption, to estimate causal effects when randomization is not feasible. Methods like difference-in-differences are common in this setting.