The price of beer in Abu Dhabi and Sharjah

In my ECONS102 class, we discuss the difference between a market where the sale and purchase of a good is illegal, and a market where the sale and purchase of the same good is legal. One surprising result is that it is not certain that the good will be more expensive in the market where it is illegal.

Consider the example of the market for beer in Abu Dhabi and Sharjah (two of the United Arab Emirates). Alcohol sale and consumption is legal in Abu Dhabi (although public intoxication is not), whereas alcohol sale and consumption are illegal in Sharjah (see here or here). Now consider the difference in the price of beer between the two markets. We can demonstrate this with a supply and demand diagram, as shown below. Demand for beer will be lower in Sharjah (DS) than in Abu Dhabi (DA), because consumers must consider the risk of punishment for consuming alcohol in Sharjah, whereas there is less risk in Abu Dhabi (unless the consumer is drunk in public). Similarly, the supply of beer will be lower in Sharjah (SS) than in Abu Dhabi (SA), because sellers face higher costs in Sharjah, due to the costs associated with the punishment of being caught.

Now compare the equilibrium price and quantity in each emirate. The quantity of beer traded (adjusted for population differences) is higher in Abu Dhabi (QA) than in Sharjah (QS). However, the equilibrium price of beer is lower in Sharjah (PS) than in Abu Dhabi (PA). How can this be? Notice that the difference in demand between the two countries is larger than the difference in supply. A lower supply increases the equilibrium price, while a lower demand decreases the equilibrium price. The two effects offset each other, so when the demand difference is larger, the net effect is a lower price. If, instead, the difference in supply was larger than the difference in demand, then the price would have been higher in Sharjah than in Abu Dhabi. And if the differences in supply and demand were exactly the same, then the price would have been the same in both emirates. In other words, while the difference in quantity is clear, the difference in equilibrium price is ambiguous - the price could be higher, lower, or the same in Sharjah as in Abu Dhabi, depending on the relative difference in supply and demand.

That the price may be lower where a good is illegal is quite counter-intuitive. The reason why this result is counter-intuitive is because most people jump immediately to what they think the price difference should be, and try to work backwards from that. However, economists know that you should never reason backwards from a price change. Instead, economists use a model (in this case, supply and demand) and work out the difference in price as the last step in the process (not the first step).

The result is counter-intuitive, but is it realistic? According to the website Expatistan, the price of a beer at a neighbourhood pub in Abu Dhabi is 40 Dirham, while the price of the same beer in Sharjah is 31 Dirham. [*] So, it may be realistic. Surprising as it may be, a good sold in a place where it is illegal may not be more expensive than the same good sold in a place where it is legal.

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[*] I have no idea how they gathered the price data for Sharjah. It is apparently based on seven observations as of June 2022, so I'm taking it at face value.