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The Economics of Legal Marijuana Markets

July 9, 2014

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Legal Marijuana Markets are Now a Reality

Legal markets for marijuana, long discussed as a theoretical possibility, are now a reality in the United States

Many states have legal markets for medical marijuana

In 2014, legal markets for recreational marijuana opened for business in Colorado and Washington

Several other jurisdictions, including Alaska, Oregon, and Washington, D.C. may follow

How are these markets supposed to work, and what problems are they likely to encounter?

July 9, 2014 Ed Dolan’s Econ Blog

The Non-Legal Market

Figure 1 shows a stylized version of the market for non-legal marijuana in a single state

The supply curve is fairly elastic, because even a small price increase will draw in supplies from other states or countries

The demand curve is less elastic, similar to inelastic demand for other recreational drugs like alcohol and tobacco

In equilibrium, 1,000 kg per month is sold at a retail price of $12 per gram

July 9, 2014 Ed Dolan’s Econ Blog

Intended Effects of Legalization (Supply)

Figure 2 shows the intended effects of legalization

A new supply curve, SL, represents the supply of legal marijuana

It is less elastic because (in versions of legalization tried so far) all legal marijuana must be grown in-state

However, at least for moderate quantities, costs should be lower because plants can be grown in daylight rather than artificial light, security costs for growers are less, no risk of arrest, and so on

July 9, 2014 Ed Dolan’s Econ Blog

Intended Effects of Legalization (Demand)

There is also a new demand curve for legal marijuana, DL

It lies to the right of the non-legal demand curve DN because: Most user of the non-legal product

will presumably patronize legal stores if the price and quality are the same or better

Some new users will be attracted when the risk of prosecution is lifted

July 9, 2014 Ed Dolan’s Econ Blog

Putting Non-Legal Suppliers out of Business

If the supply curve for legal marijuana is low enough and if the demand curve shifts only moderately, then legal marijuana will be cheaper than the non-legal product and non-legal suppliers will become uncompetitive

If the quality, convenience, and safety of the legal product is perceived as superior, the shift away from non-legal suppliers will happen more rapidly

July 9, 2014 Ed Dolan’s Econ Blog

The Risk of Over-regulation

There is a risk that over-regulation may restrict the supply of legal marijuana

For example, taxes in Washington State are high (35-40% of retail price) and approval of licenses was very slow

Also, continued illegality at the Federal level makes it hard for growers and stores to open bank accounts and conduct normal business

These and other factors can lead to a shortage of legal marijuana and the supply curve SL may intersect the demand curve at a price above the prevailing non-legal price

July 9, 2014 Ed Dolan’s Econ Blog

A Split Market

Over-regulation leads to a split market, as shown here, in which the majority of users buy at a lower price from their non-legal suppliers

The legal market is only able to attract a small population of new users who are willing to pay higher prices to get the legal product

July 9, 2014 Ed Dolan’s Econ Blog

Early Experience

Early experience in Colorado and Washington shows mixed results

A well-developed medical marijuana market in Colorado and lower taxes helped that state overcome supply problems for legal marijuana more rapidly than Washington

The non-legal market did not disappear immediately in either state, but there are signs that it will gradually wither away, just as the non-legal market for moonshine whiskey did after the end of prohibition in the 1930s.

July 9, 2014 Ed Dolan’s Econ Blog

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