Abstract
Retail prices of illicit drugs are volatile, and have fallen despite rising supply disruption. This article presents and empirically tests a model to explain this apparent price puzzle. Supply disruption increases the cost of purity. Illicit drugs are experience goods, with demand depending on the seller's purity reputation. There is an equilibrium in which supply disruption decreases purity, reducing future demand and prices. These predictions are tested using monthly data for crack cocaine in Washington DC. Persistence of the series is exploited to handle endogeneity resulting from seizures mirroring supply. A 10% increase in seizures reduces purity by 4.7% and future prices by 2.3%.
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