CHAPTER 1

THE ECONOMICS OF ADDICTION

When discussing addictive behavior we need a clear definition of the termaddiction. It is not difficult to find definitions of addiction. The truly difficulttask is deciding which of the phenomenally similar, but not identical, definitionsto present. Here are two examples:

• a physiological and psychological compulsion for a habit-forming substance.In extreme cases, an addiction may become an overwhelmingobsession (http://www.personalinjuryfyi.com/glossary.html)

• a chronic, relapsing disease characterized by compulsive drug-seekingand use and by neurochemical and molecular changes in the brain(http:www.tobaccofreeqc.org/youth/glossary.php)

With words such as compulsion, obsession, and disease used to define it, addictionis certainly not considered to be a beneficial activity. Even healthy activitiessuch as exercising or eating well acquire the label exercise nut or health nutfor those who practice them excessively.

The American Psychiatric Association offers a more thorough definition:

Answer yes or no to the following seven questions. Most questions have morethan one part, because everyone behaves slightly differently in addiction. Youonly need to answer yes to one part for that question to count as a positiveresponse.

1. Tolerance. Has your use of drugs or alcohol increased over time?

2. Withdrawal. When you stop using, have you ever experienced physical oremotional withdrawal? Have you had any of the following symptoms: irritability,anxiety, shakes, sweats, nausea, or vomiting.

3. Difficulty controlling your use. Do you sometimes use more or for a longertime than you would like? Do you sometimes drink to get drunk? Doyou stop after a few drinks usually, or does one drink lead to more drinks?

4. Negative consequences. Have you continued to use even though therehave been negative consequences to your mood, self-esteem, health, job,or family?

5. Neglecting or postponing activities. Have you ever put off or reduced social,recreational, work, or household activities because of your use?

6. Spending significant time or emotional energy. Have you spent a significantamount of time obtaining, using, concealing, planning, or recoveringfrom your use? Have you spent a lot of time thinking about using?Have you ever concealed or minimized your use? Have you ever thoughtof schemes to avoid getting caught?

7. Desire to cut down. Have you sometimes thought about cutting down orcontrolling your use? Have you ever made unsuccessful attempts to cutdown or control your use?

If you answered yes to at least 3 of these questions, then you meet the medicaldefinition of addiction. (http://www.addictionsandrecovery.org/definition-of-addiction.htm)

Although less judgmental than the previous definitions, an underlying negativefeel is still associated with this more complete definition.

In contrast, the standard economic definition of addiction is judgmentfree. Here is an example taken from the seminal work on the economics ofrational addiction (Becker and Murphy, 1988):

The basic definition of addiction at the foundation of our analysis is that aperson is potentially addicted to a good if an increase in his current consumptionof the good increases his future consumption of the good. (681)

That may not be an elaborate definition, but it has some strong points in itsfavor. Unlike many of the other definitions of addiction, the economic definitiondescribes behavior, it does not condemn it. Quite simply, addictive behaviordepends on how consumption in one period affects consumption inanother period. If the more you smoke today, the more you want to smoketomorrow, smoking is addictive. But likewise, if the more you exercise today,the more you want to exercise tomorrow, exercising is addictive. With thisdefinition, you can consider the consumption of any good to be potentiallyaddictive. Furthermore, there is no reason to identify or distinguish betweenphysical addiction and psychological addiction. The only important trait toidentify is a person's consumption pattern over time.

Thinking about addiction as a consumption issue allows us to raise thetypes of questions in which an economist specializes. How do price changesaffect the consumption of addictive goods? What about income changes, informationchanges, or the costs of quitting? How do regulations or criminallaws affect consumption? More generally, we can challenge the premisethat addicts are somehow "trapped" by their addiction. As we do with otherconsumer products, we can predict that addicts make rational choices whenconsuming addictive goods. In other words, an addict will rationally chooseto trade off short-term benefits (getting high) with long-term costs (futurehealth problems). If addicts are making these trade-offs, we must address preciselyhow they compare future costs to current benefits. This comparison liesat the heart of the economic theory of addiction.

The Subjective Rate Of Time Preference

Consider the following thought experiment. You are asked to choose betweenthe following two options: receive $1,000 today or receive $1,000 exactly oneyear from today. Which option would you choose, keeping in mind that thereis no right or wrong answer? By far, the most common choice is the $1,000today, and let's assume that's your choice also. How would you answer a follow-upquestion: Would you prefer $1,000 today or $1,100 one year from today?Still the $1,000 today? How about $1,200 in one year? Not enough? How about$1,300, $1,400, or as much as $1,500? What would it take to get you to choosethe future amount? Eventually, we can find a future amount that you wouldchoose over the current amount of $1,000. What this experiment is tryingto demonstrate is that, dollar for dollar, we prefer current dollars over futureones. In fact, most of us must be paid a premium, perhaps a large premium,before we're willing to give up a current payment for a future one. More succinctly,most people tend to be impatient to some degree, while addicts areoften thought of as being highly impatient.

Economists have a simple tool for numerically measuring a person's levelof impatience—the discount factor (usually depicted by the symbol d, theGreek letter delta). Using the hypothetical example from above, assume thatyou are perfectly indifferent as to whether you receive $1,000 today or $1,500one year from today. What is meant by "perfectly indifferent" is that if youare offered $1,499 one year from today, you strictly prefer the current amountof $1,000, and if you are offered $1,501 one year from today, you strictly preferthe future amount of $1,501. At $1,500 one year from today, you trulydon't see a difference between the current and the future options. In this case,because the current amount of $1,000 is equivalent to the future amount of$1,500, we can say that you discount the future amount by two-thirds (1,000/ 1,500). Equivalently, we can say that you have a discount factor of two-thirds,or d = .67, approximately.

In economic terms, the discount factor is a measure of a person's rate oftime preference. How impatient is a person when considering current versusfuture trade-offs? As the discount factor becomes larger (closer to 1), the personis less impatient (or more patient). As the discount factor becomes smaller(closer to 0), the person is more impatient (or less patient). It is very importantto recognize that the discount factor is a subjective measure of impatience. Toa typical economist, there is no such thing as a right or wrong (or a good orbad) level of impatience. A rate of time preference is precisely that—a preference.Yet, when scholars discuss public policy justifications for controllingaddictive behavior, addicts' supposed shortsightedness is often at the top ofthe list of justifications.

The concept of impatience is of paramount importance when discussingaddictive behavior, and we examine it in careful detail. Typically, addicts arethought of as being more impatient than nonaddicts. In its simplest form,addiction is a trade-off between the current benefits the addict reaps fromsmoking, drinking, using drugs, and so on, and the future costs the addictwill bear from poorer health or increased health care costs. Compared totheir farsighted counterparts, shortsighted (or myopic) people place littleweight on future outcomes, so the current benefits of drug use, for example,are given more weight than the future health costs. Farsighted people, on theother hand, place more weight on future health costs, making them less likelyto indulge in excesses today.

Impatience is a crucial quality to consider when discussing many typesof behaviors, not only addiction. Consider the war against terrorism. One ofthe most frightening weapons some terrorists use is themselves. How do wefight someone willing to strap on a bomb and detonate it in a public place? Asuicide bomber is likely to have an extremely low discount factor—they placevirtually no value on future events. This makes it very difficult to deter suicidebombers. If they don't care about the future, if they don't even care abouttomorrow, the threat of future punishment has no effect on them.

In a similar vein, criminals in general are believed to be far more shortsightedthan noncriminals. A typical criminal weighs the current benefitsof committing a crime against the future costs of apprehension, conviction,and punishment. A very myopic criminal is not easily deterred by the threatof future imprisonment. Severe penalties, such as the three-strikes law thatharshly punishes a third offense, or hard labor, or capital punishment, areoften justified as necessary sanctions to discourage certain costly criminalbehavior.

It is not uncommon, on the basis of these examples, for shortsightedpreferences to be associated with behaviors that are often considered bad orcostly, not only from a social perspective but from an individual perspectiveas well. It is sometimes suggested that education or information would helpshortsighted people become more patient, and that very well may be true.But economists usually view myopia as a preference, and it is not a simplething to change someone's preferences. In fact, economists typically take preferencesas given, meaning that we have very little to say about them otherthan that they exist. We may be able to predict different behaviors accordingto different levels of impatience, but we don't often criticize preferencesthemselves.

The Rational Addict

Describing addiction as a rational act is a result of accepting preferences asgivens and making no judgments. Precisely how does a rational addict behave?Assume you are deciding whether to begin smoking today. You know that ifyou start smoking, it will affect how much you want to smoke in the future.You also know that, whatever benefits you reap from smoking, eventually youwill face adverse effects and long-term health costs. If you are fully informedabout all the benefits and costs of smoking throughout your entire life, you candecide if your lifetime costs of starting to smoke today exceed the future benefitsor if it is the other way around.

But knowing future benefits and costs of smoking is only the startingpoint. You can't just add up all the benefits, add up all the costs, and see whichis the larger of the two. You must also consider your rate of time preference.Any costs or benefits that accrue to you in the future need to be properly discountedto be comparable in a current sense. A $1,000 cost 10 years from nowis not the same, in a current sense, as a $1,000 cost 9 years from now, whichis not the same as a $1,000 cost 8 years from now, and so on. The further intothe future you expect to receive a benefit or cost, the less it is worth to youtoday. Thus, if most of the benefits from smoking are in the near future, andmost of the costs, even if substantial, are in the far future, you may give moreweight to the current benefits of smoking than the future costs.

For a proper rational calculation of all the benefits and costs, you mustapply your subjective discount factor to all future values. Still, the fundamentalcost-benefit analysis for you is basically the same. Once you calculate yourcurrent value of all the benefits and costs of smoking today, you can then decideyour best course of action. Notice, with this reasoning, both decisions—to start smoking or to refrain from smoking—can be fully rational acts.Smoking is like any other activity. If you decide to smoke, it is because youbelieve it is in your best interest. It is not that there are no costs to smoking,it is just that those costs (properly discounted) are outweighed by the benefits(also properly discounted).

While the concept of rational addict has appeal as a theoretical construct,this simple representation has problems. Most obviously, why should we believethat you are fully informed about all the costs and benefits of consumingan addictive product throughout your life? It may not be difficult to believeyou understand the benefits, as they are often largely subjective, but how welldo you truly appreciate the long-term health risks of your addictive behavior?Do you fully understand the costs associated with excessive smoking, drinking,or eating? Informational deficiencies offer an important justification forsocial policy intervention to protect people from themselves, and this is discussedin later chapters. What is far more interesting, however, is that theremay be shortcomings to the rational-addiction model even when you are fullyinformed. You may make a rational, fully informed decision to start smokingthat is correctly based on every cost and benefit you experience throughoutyour life yet still end up regretting your decision. This is where the behavioraleconomists step in.

Printers, Rebates, and Time Consistency

Thinking about addiction in a rational framework presents a challenge formany people, as it may be difficult to accept economic results based on modelsin which a person chooses to consume harmful addictive goods such as drugs orcigarettes. Sometimes an example involving a product that everyone can easilyrelate to clearly illustrates key concepts. The decision to purchase a computerprinter offers just such an example.

Let's assume Tim, Nate, and Sophia are all considering purchasing a specificcomputer printer. This particular printer has all the features they desire,but they find the price just a little too high. At the listed price, none of themchoose to buy the printer. Fortunately for them, the company that producesthe printer is offering a rebate special. A rebate deal involves actions in threedistinct periods. In the first period, you decide whether to buy the printer. Ifyou do buy it, in the second period you do whatever is necessary to qualifyfor the rebate. For example, you may have to fill in some paperwork, go tothe post office, participate in an online or telephone customer service survey,and so on. In other words, you must bear a cost to submit the rebate request.If you submit the rebate request, in the third period you receive your rebate.How you approach a rebate deal depends on what type of person you are.

Let's start with Tim. Tim will pay the high price this period only if he planson submitting the rebate request next period. He knows that, in the future, hewill incur a cost of submitting the request, but further into the future he willreceive a benefit. To make his decision, he asks himself a question: If I buy theprinter this period, will I submit the rebate request next period? To answerthat question, Tim has the ability to think of himself as being in the secondperiod. From that perspective, he incurs a current cost but receives a futurebenefit, and when properly calculating the current value (that is, discountingthe future benefit), he finds it in his best interest to submit the request. Knowingthat he will submit the rebate request, Tim (in the first period) calculatesthe current value of buying the printer, submitting the request, and receivingthe rebate. On the basis of his properly discounted cost-benefit calculation,Tim decides to buy the printer this period. He follows through and submitsthe rebate request next period, and he receives his rebate in the third period.

Now let's turn to Nate. Nate faces the same decision that Tim does, butNate approaches the problem in a slightly different way. Nate does not havethe ability to project forward and think of himself as being in the second period.Instead, Nate makes his decision from only the first period's perspective.So Nate discounts both the future cost of submitting the rebate request andthe future benefit of receiving the rebate, and he finds that it is in his best interestto buy the printer with the intention of requesting the rebate. But thereis a twist. After buying the printer and getting to the second period, Natemust now decide if he wants to incur the cost of submitting the rebate request.To do this, he calculates the current (second period) value of the future (thirdperiod) benefit, compares it to the current cost, and finds that the cost outweighsthe benefit. In other words, when actually in the second period, Natedoes not find it worthwhile to submit the rebate request. Nate ends up buyingthe printer, not submitting the rebate request, and not receiving a rebate.Thus, Nate ends up with a printer he does not value at the price he paid.

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