Cobweb dynamics and price dispersion in illicit drug markets
Extreme price dispersion is a hallmark of illegal drug markets, and this apparent contradiction to the law of one price has long puzzled drug market economists. We propose a novel explanation for this dispersion: the coupling of dealers' unwillingness to hold inventory with dealers' imperfect foresight concerning future prices and/or random lead times when "ordering" drugs from higher-level suppliers. Unwillingness to hold inventory means drug markets might operate consistent with a cobweb model. The classic cobweb model was inspired by the observation of cyclic (typically annual) fluctuations in commodity prices. However, with minor changes that make the model more realistic the resulting price trajectories can be highly variable or even chaotic, not just periodic. Cobweb dynamics can also amplify the variability created by supply chain disruptions.
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