Optimal Drug Policy in Low-Income Neighborhoods.

The control of drug activity currently favors supply-side policies: drug suppliers in the U.S. face a higher arrest rate and longer sentences than demanders. We construct a simple model of drug activity with search and entry frictions in labor and drug markets. Our calibration analysis suggests a strong "dealer replacement effect." As a result, given a variety of community objectives, it is beneficial to lower supplier arrests and raise the demand arrest rate from current values. A 10% shift from supply-side to demand-side arrests can reduce the population of potential drug dealers by 22-25,000 and raise aggregate local income by $380-400 million, at 2002 prices. (JEL Classification: D60, J60, K42, H70).