The Retail Market for Illicit Drugs

Outlawing a market is often the first step in the design of the illegal black market that results. Here's a paper from the most recent AER on the market for crack cocaine:

A Structural Model of the Retail Market for Illicit Drugs
By Manolis Galenianos and Alessandro Gavazza

Abstract: We estimate a model of illicit drugs markets using data on purchases of  crack  cocaine.  Buyers  are  searching  for  high-quality  drugs,  but  they determine drugs’ quality (i.e., their purity) only after consuming  them.  Hence,  sellers  can  rip  off  first-time  buyers  or  can  offer  higher-quality drugs to induce buyers to purchase from them again. In  equilibrium,  a  distribution  of  qualities  persists.  The  estimated  model  implies  that  if  drugs  were  legalized,  in  which  case  purity  could be regulated and hence observable, the average purity of drugs would  increase  by  approximately  20  percent  and  the  dispersion  would decrease by approximately 80 percent. Moreover, increasing penalties may raise the purity and affordability of the drugs traded by increasing sellers’ relative profitability of targeting loyal buyers versus first-time buyers.