A Behavioral Economic Approach to Measuring the Economic Impact of the Legalization of Marijuana
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Transcript of A Behavioral Economic Approach to Measuring the Economic Impact of the Legalization of Marijuana
A Behavioral Economic Approach to Measuring the
Economic Impact of the Legalization of Marijuana
Jeff Lee
ECON-490
Professor Wade Shilts
11-23-10
Abstract
The debate about the legalization of marijuana is one of the most heated debates in the
United States today. In fact, it has been ongoing for decades. Whether it is on T.V., in
newspapers, in magazines or on the Internet—we are constantly being thrown statistics—such as
how much tax revenue it will generate if it were legalized and taxed, the total worth of the
marijuana industry, . One of the major problems associated with all of these claims is the fact
that the marijuana industry exists ―underground‖ because it is illegal under Federal Law.
Consequently, we are left with incomplete information and uncertainties regarding key economic
variables needed to make accurate projections—such as its price elasticity of demand and its
cross-price elasticities with tobacco and alcohol. A more effective, yet often overlooked
approach is to analyze the effects of legalization on individual behavior using microeconomic
principles and theories. By doing so, we can better predict both consumer and producer behavior,
and in turn, be able to draft and implement successful policies to achieve the goals we want.
Based on this analysis, it can be concluded that there will likely be an increase in consumer
demand and consumption in the short-run, as well as a decrease in revenue and profit for illegal
suppliers (leading them to either become legal or leave the marijuana industry). Moreover, if
aggregate demand and supply act in the same fashion, the marijuana market will be transformed
from an illegal, oligopolistic market into a legal, perfectly-competitive market.
1
Introduction
Background
The debate about the legalization of marijuana is one of the most heated debates in the
United States today. In fact, it has been ongoing for decades. Marijuana is now more engrained
in our society than ever before. Its presence is everywhere—it is grown in homes, backyards,
even national parks. Its cultivation has now spread to all 50 states (Marijuana USA) and many
local economies around the country financially depend on the marijuana industry. In Mendocino
County, located in northern California, the marijuana industry accounts for approximately two-
thirds of the local economy (Marijuana Inc.). In fact, it is widely accepted that this region of the
state represents the largest supply of marijuana in the country, which has contributed to the
region’s nickname of ―The Emerald Triangle.‖ Marijuana’s availability can be easily identified
throughout the country, even in middle schools. According to the 2009 National Survey on Drug
Use and Health, almost half (49.9%) of youths between the ages of 12 and 17 reported that it
would be ―fairly easy‖ or ―very easy‖ for them to obtain marijuana (SAMHSA). In addition, the
rate of current marijuana use among young adults between the ages of 18 and 25 is estimated to
have increased from 16.5% to 18.1% (SAMHSA).
Not only is marijuana the most widely used illegal drug on the market, but it is also the
nation’s leading cash crop and is widely considered to be one of the most profitable industries
that exists in America. One of the reasons for this is due to the large profit margins that one can
achieve after getting involved in the industry. One study conducted by Cliff Schaffer in 2007
estimated how much annual profit one could earn if he or she were to acquire a 10’x10’ room
with five lights of 1,000 watts each. The conclusion was that this would result in $118,000 in
2
total sales per year with an annual cost of electricity of $3,000; thus yielding a net annual profit
of $115,000 (MarijuanaBusinessNews). With this kind of profit potential, it is easy to see why so
many people choose to overlook the risk of punishment and get involved in this lucrative
industry.
In 1973, Oregon became the first state to ever enact a decriminalization law. Today,
thirteen states have, to some extent, decriminalized marijuana (NORML). Looking across these
states, there are noticeable differences in how much marijuana each state legally permits a
twenty-one year old or older to possess at one time, as well as noticeable differences in the
severity of fines. In California, for example, it is legal for people twenty-one years of age and
older to possess up to 28.5 grams (about an ounce) of marijuana without arrest—instead, they
can only receive a maximum fine of $100. As a result of the enactment of decriminalization laws
such as these, the United States has experienced the rapid growth of medical marijuana
dispensaries. The total number of dispensaries are increasing in number each month, and in the
city of Denver, Colorado, there are now more medical marijuana dispensaries than there are
Starbucks Coffee Shops and liquor stores combined (Marijuana USA).
Despite state decriminalization laws, marijuana is still 100% illegal under Federal law
due to the Commerce Clause of the United States Constitution. Under this clause, Federal
authorities are permitted to prosecute any and all offenses of Federal laws (Constitution). In the
2005 case of Gonzales v. Raich, the U.S. Supreme Court ruled, with a vote of 6 to 3, in favor of
the opinion that even where persons are cultivating, possessing, or distributing medical cannabis
in accordance with state-approved medical cannabis laws, such persons are violating federal
marijuana laws and can therefore be prosecuted by federal authorities (Gonzales v. Raich). This
3
ruling essentially placed federal marijuana laws above state marijuana laws and has ever since
fueled the tension between the violators of federal law and the authorities that catch them.
As a result of these laws, the Federal Drug Enforcement Agency (DEA) routinely targets
and arrests medical cannabis patients, as well as seizes medical marijuana and business assets of
growers and medical marijuana dispensaries. All together, there are hundreds of thousands of
marijuana-related arrests every year nationwide. The year 2009 saw 858,408 marijuana-related
arrests (51.6% of total drug arrests)—a 1.8% increase from 2008, which saw 847,863 marijuana-
related arrests (49.8% of total drug arrests)(DrugWarFacts). After coming across such high
numbers, is it out of line to want to know how much money is actually being spent enforcing
federal marijuana laws? What about figuring out how many total marijuana users there are in the
U.S.? Has usage of the drug been increasing in recent years? How much money in tax revenues
would our national economy gain if marijuana was to be legalized and taxed similarly to that of
alcohol and tobacco?
Two Critiques
So called ―answers‖ to questions like these are thrown around all the time–both in the
media, and on the streets. For example, the Substance Abuse and Mental Health Services
Administration estimated that in 2009, there were approximately 17 million ―current‖ users of
marijuana who claimed to have consumed the drug at least once per month over the entire year—
which accounts for about 7% of the population (Marijuana Facts). The organization also
estimates that the number of ―current‖ (i.e. monthly) marijuana consumers increased by 11.7%
from 2002 to 2009 (Marijuana Facts).
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Most recently, Harvard Director of Undergraduate Studies Jeffrey A. Miron (PhD in
Economics) and Stern School of Business doctoral student Katherine Waldock conducted a study
to determine the overall economic impact of the legalization of marijuana. Their research was
published this year by the well-respected CATO Institute. They concluded that the legalization of
the drug would save roughly $41.3 billion per year in national government enforcement
expenditure (Budgetary Impact). They also concluded that if the drug were to be legalized and
taxed at rates similar to those of alcohol and tobacco, this would yield a national tax revenue of
about $46.7 billion annually (Budgetary Impact). These numbers are the most recent and widely-
accepted estimates of these two measures.
While it must be acknowledged that the pursuit of accurate estimates is a necessary and
respectable practice when required to determine essential, yet difficult-to-obtain figures, there
are two problems that result when these estimates are taken and used as facts within debates that
attempt to determine the impact of the legalization of marijuana. The first problem with
estimates like these is that they are based on a variety of incomplete information and
uncertainties, which consequently renders them almost useless when designing a marijuana
legalization law. Many forget the fact that the marijuana industry exists outside of the legal
framework—and because it does, there is so much information that we do not know because it
simply never gets documented in any way! No one knows exactly how many current users of
marijuana there are, nor does anyone know exactly how many illegal suppliers (growers and
non-growers) there are. No one even knows the exact net economic benefit of legalizing
marijuana.
In addition to these unknown numbers, we are also left with an abundance of nearly-
unquantifiable variables. For example, we do not know the exact per-unit price of marijuana,
5
since it ranges from both state to state and from county to county across the United States. We
also do not know exactly how marijuana consumers respond to changes in price (i.e. the price
elasticity of demand), nor do we know its exact cross-price elasticity with tobacco or alcohol
(which is needed in determining the net economic benefit; the gain in marijuana tax revenue
must not be offset by unintended consequences that result in other industries). Other
uncertainties include the effect of marijuana consumption on one’s health and development (still
being researched), as well as the social costs of federal law enforcement.
The second problem that follows is that people and interest groups cite particular
―estimates,‖ which vary across all kinds of different news sources, and often skew them to reflect
their own personal bias either in favor or against marijuana legalization. Considering the extreme
partisan nature of the debate itself (i.e. the vast majority of people are either for or against it; few
are ―on-the-fence‖), we should be skeptical of the plausibility of the numbers we hear (Caputo).
The heated debate that surrounded the recent Proposition 19 bill in California is a great
illustration of these two problems. Had the bill passed, it would have made it legal, under state
law, for consumers twenty-one years of age and older to possess up to one ounce of marijuana
for personal consumption—without being arrested or receiving a fine (BOE). In general, both
supporters of the bill and those in opposition cited many common-themed arguments to support
their stance on the issue. One of the most common arguments made amongst supporters was that
the ―War on Drugs‖ is failing in that the costs of enforcement are far outweighing the benefits.
Yet, another common claim that was brought up frequently was that under Proposition 19,
California should expect to gain about $1.4 billion in additional tax revenue (Miron article:
Don’t Buy the Hype). Many supporters relied heavily on this one number to support their
stances, overlooking that it was, in fact, just an ―estimate‖ based on the limited information and
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uncertainties surrounding significant variable measurements. Simply declaring ―$1.4 billion‖
does not automatically end a debate, let alone even constitute a decent argument.
Many opponents of Proposition 19 also followed this habit with the popular claim that
legalizing marijuana would seriously threaten the health and safety of the general public. In
addition, many made the claim that the consumption of marijuana has severe health risks on the
individual and increases the social cost on those around that individual. While this too may seem
like an acceptable argument, it overlooks the fact that there are uncertainties regarding the effect
of marijuana consumption on the health of an individual user, as well as uncertainties about what
its actual social cost on society is (if any). Research is still being conducted on this issue—and
one key counterargument to the claim that marijuana is ―bad‖ for users is that the reason for the
existence of medical marijuana is because studies have shown that there are indeed some
identifiable medical benefits from marijuana. This argument too, however, is unclear because
these potential benefits are still being explored. In the end, the bill was placed on the California
statewide ballot, and on November 2nd
, 2010, about 54% of the voters voted ―no‖ while 46%
voted ―yes.‖
A More Effective Approach
In response to the presence of limited data and uncertainties surrounding all sorts of
statistics regarding the effects of marijuana legalization, it can be argued that a more effective
approach to accurately determining the effects of legalization on the economy is to analyze it
using the principles of behavioral economic theory. By focusing on how individual consumers
behave, as well as on how individual illegal suppliers behave, we can create a step-by-step model
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that shows the theoretical effects of legalization on each of these two individuals, as well as the
theoretical implications these have on the entire market.
This project is not about promoting marijuana or declaring that it should be legalized. It is
not about spreading opposition to legalization. In fact, this project doesn’t even make any
definitive stance on either side, nor does it attempt to determine any numerical value associated
with potential economic benefits of legalization (if any). Instead, the goal of this project is to
provide as much of an unbiased perspective on the issue as possible, and in addition, take a more
original approach and focus on what microeconomic principles and theories have to say about
the effects of legalization. Such an approach will prove to be much more powerful and
worthwhile than spending a large amount of time attempting to accurately quantify particular
measurements that nearly impossible to accurately determine in the first place! Again, this is due
to our lack of sufficient information about an industry that mostly exists ―off-the-grid.‖
In addition, by observing and investigating all sorts of cause and effect relationships
within behavioral economic theories, our understanding of how the creation of a legal marijuana
market would work will substantially increase, and, in short, policymakers will be able to draft
more attractive and successful legalization proposals within their respective states.
The Behavioral Theory Model
Defining Legalization
Before attempting to create the model, it is essential to first clarify and define what is
meant by ―legalization,‖ as well as to identify the difference between legalization and
decriminalization. First of all, ―decriminalization‖ refers to the reduction of penalties associated
with being caught for possession. Such penalties include eliminating jail time sentences for first-
8
time offenders, as well as eliminating criminal charges. Under decriminalization, however, it is
still illegal to sell or possess marijuana, unless you own a medical marijuana license approved by
the state. Even then, though, anything having to do with marijuana is still 100% illegal under
Federal law and probably will be for a long time.
Legalization, on the other hand, refers to the ability of the drug to be sold, regulated, and
taxed legally within its respective state. It means that anyone twenty-one years of age and older
can legally possess, within the state, a particular amount of marijuana for personal use only, with
or without a medical marijuana license. It is also legal for anyone twenty-one years of age and
older, living within the state, to start up his or her own small business within the industry—
granted he or she (1) becomes a licensed supplier, and (2) cooperates with the government in
making sure they government receives their tax money. However, keep in mind that despite the
passing of any state law legalizing marijuana, the drug will still be considered 100% illegal under
federal law no matter what.
Defining the Framework of the Model
For our model, we must first choose a location: we will assume that we are in the state of
Iowa, where marijuana is currently both criminalized and outlawed under both state and federal
laws. Next, we will use several basic behavioral economic principles and graphs to show what
the current situation (Pre-legalization) looks like for both an individual consumer (who we are
going to call: Oliver) and an individual illegal supplier (who we are going to call: Scott). We will
then use this to derive aggregate demand and aggregate supply curves and show what the overall
marijuana market looks like as it is now (Pre-legalization).
9
Then, we will introduce legalization into the model and show how this influences and
changes the behavior of both individuals (Post-Legalization). We will also derive the new
aggregate demand and aggregate supply curves, as well as show the impact of legalization on the
marijuana market overall—in the short run and in the long run. Furthermore, we will summarize
our findings and identify the implications, potential problems, and complications associated with
our model.
Pre-Legalization – Consumer Behavior
To begin to tell the story, we will use the concept of utility maximization, which states
that the goal of a consumer is to maximize his or her utility, or satisfaction, subject to a set of
constraints (factors that influence one’s consumption). In our example, when purchasing
marijuana, Oliver’s goal is to maximize his utility, or satisfaction, for marijuana subject to four
constraints: (1) his budget, (2) his perceived health risk, (3) his perceived risk of being caught by
both state and federal law enforcement, and (4) the availability of marijuana.
Now, let’s invent the scenario in which Oliver is looking to buy marijuana from an illegal
supplier. We will not need to specify his exact desired amount, nor are we going to provide a
range of prices from which he is willing to pay—both are irrelevant to this particular model.
Instead, what is relevant is how he chooses who to buy from. Before we can determine this, we
must first make six key assumptions. Our first assumption is that (1) Oliver has relatively easy
access to the drug. Our second assumption is that, in choosing between two illegal suppliers, (2)
Oliver will choose to make his entire purchase from one illegal supplier or the other—he will not
buy partial amounts from both. Thirdly, we will assume that (3) he will buy from the illegal
supplier who is offering the lowest price per unit—which calls for our fourth assumption that (4)
10
there is little to no difference between the quality of each product (while this might not be the
case, we will make this assumption for simplicity). Fifth, we will assume that (5) if two illegal
suppliers are offering Oliver the same price per unit, then Oliver will be indifferent between
which of the two illegal suppliers to buy from. Lastly, we will assume that (6) the risk of running
into state and federal law enforcement is the same for all possible transactions.
One way we can model Oliver’s preferences is by graphing indifference curves, which
represent sets of bundles among which he is indifferent. Figure 1 shows three indifference curves
that reflect Oliver’s preferences outlined in these assumptions above. As you can see, he has
access to two illegal suppliers (note: these can be either growers or non-growers). Both the
quality and price of each product are also nearly identical (as evident in the near 1:1 slope of the
indifference curves), which suggests that Oliver sees the two products as nearly perfect
substitutes—which are defined as two goods that a consumer places equal value upon. The near
1:1 slope also takes into account that the risk of running into law enforcement is the same in each
case.
11
Next, we will derive Oliver’s basic demand curve in Figure 2. Note that the slope of the
demand curve is arbitrary, considering we lack information about his responsiveness to price
changes (i.e. price elasticity of demand). However, note that his demand curve is downward
sloping because it shows that the basic law of demand holds in our model—as price of the good
increases, Oliver’s quantity demanded goes down (and vice-versa). From this, we can derive a
theoretical aggregate demand curve by taking the sum of all the individual demand curves in the
market for illegal marijuana, which notably do not have all the same slopes.
Pre-Legalization – Illegal Supplier Behavior
Now, we can look at the supply side of the current market using Scott as our illegal
supplier of marijuana. We will start this analysis by claiming that the goal of an individual
supplier is to maximize his or her profits. Equation 1 shows how Scott’s profit is calculated: by
taking his total revenue minus his total cost, which is also equal to output price times output
quantity minus input price times input quantity.
(Eqn. 1) Π = TR – TC = [(Pout)(Qout)] – [(Pin)(Qin)]
12
Similar to Oliver, Scott is also subject to a list of constraints. There are seven factors that
influence Scott’s distribution: (1) his available client base (i.e. the number/availability of
buyers), (2) input costs, (3) expectations, (4) technology, (5) weather, (6) perceived risk of
running into state and federal law enforcement, and (7) his competition (i.e. other illegal
suppliers around him).
Taking all of these into account, we can graph Scott’s individual supply curve in Figure
3. As you can see, his supply curve is upward sloping, which shows that the law of supply holds
in this scenario (i.e. Scott will tend to offer more of his product at a higher price). Similar to how
we derived the aggregate demand curve, we can derive the aggregate supply curve by taking the
sum of all the individual supply curves. To keep things simple, we will assume that the slope of
Scott’s supply curve is determined by some combination of his constraints. Also, we will not
develop a production function for two reasons. First of all, Scott could be either a grower or a
non-grower, and so since a production function would only apply to a grower, we will omit it to
keep things simple. Secondly, we will see later on that the production function would remain
unchanged after legalization, and so this is also why we will choose to leave it out of our model.
13
Now, tying everything we have together so far, we can graph what the current overall
marijuana market looks like—but before we can do that, we must first identify which type of
market best fits it. In microeconomics, we learn about three types of markets: monopolies,
oligopolies, and perfectly-competitive markets, as well as the basic features of each. To start off,
we will look at the market structure of a monopoly. The first main characteristic of a
monopolistic market is that it consists of one seller. Secondly, this one seller has the ability to
―set‖ their own selling price. As a result, they are able to set their price(s) so low that no one else
can compete, thus gaining market power and preventing other firms from entering the market
(one example would be Wal-Mart). On the other hand, a monopoly also has the ability to set
their selling price well above that which would maximize profit. As a result, they are able to
essentially gain profit on top of profit.
With this in mind, let’s look at how a perfectly-competitive market works. Firstly, it
consists of lots of sellers who are constantly in competition with one another. As a result of this,
each firm within this type of market structure become ―price-takers‖ in that they are forced to set
their price to whatever the market determines (if they try to charge above their competitors, they
will lose). Also, there are no barriers to entry in a perfectly-competitive market—thus allowing
for any new number of firms to enter the industry. Lastly, no one firm has ―market power‖
because the equilibrium price is set where price equals marginal cost.
Now, looking back on these two types of markets, which one better depicts the current
marijuana market? Of the two choices, a monopolistic market would be more accurate—
however, an even more accurate market structure would be that of an oligopolistic market.
Imagine being able to divide the entire country into small areas and look at the marijuana market
within each small area. While some areas might have one major supplier or a large number of
14
small suppliers, most places will likely a few marijuana suppliers. Also, despite the fact that
these few suppliers are in competition with each other, each are still able to charge a little more
for their products than the level which would maximize their profits (MC=MR), largely because
they are in an illegal market (there are no ―rules‖ for them to follow).
Figure 4 shows what the current oligopolistic marijuana market might look like within
Scott’s small area. In the graph on the left are the marginal cost and marginal revenue curves,
and the point at which they cross represents the point at which Scott maximizes his profits. As
you can see, however, Scott is able to set his price at a level above that which would normally
maximize his profits, which essentially gives him market power. This makes sense, considering
the large profit margin potential that exists for any illegal supplier within the industry. Going into
more detail, the graph on the right shows what different sections of the graph signify. First of all,
it shows consumer surplus in the top triangle, which represents the utility that consumers receive
by being able to purchase marijuana for a price that is less than they would be willing to pay.
Note that the size of this consumer surplus area is less than it would be if Scott wasn’t able to
charge above his normal profit-maximizing point. Moreover, Scott’s market power allows him to
increase his producer surplus—the utility he receives by being able to charge a price higher than
the minimum price he would be willing to sell his marijuana for. Lastly, the triangle on the right
represents the deadweight loss to society, or in other words, the total surplus that is lost due to
the fact that this is an imperfect market.
15
Post-Legalization – Consumer Behavior
Now, let’s introduce the legalization of marijuana into the equation and see how this
alters the individual consumer’s behavior. If marijuana is legalized, this has an immediate effect
on our individual consumer by altering Oliver’s constraints. First of all, Oliver’s third constraint
is reduced because he no longer has to worry about state law enforcement when he purchases
marijuana from a newly created legal supplier (assuming he buys within the legal limit). This
also changes his fourth constraint because legalization will increase the availability of marijuana
by adding another supply source. Both of these two constraint changes are modeled in Figure 1-
A, which models Oliver’s new indifference curves. If a legal supplier is factored into Oliver’s
decision making, Oliver will prefer buying from a legal supplier as opposed to an illegal
supplier. The new slope of the indifference curves reflects this: Oliver places more value on the
legal supplier’s marijuana because he is willing to give up a lot of marijuana from the illegal
supplier for a smaller amount of marijuana from the legal supplier.
16
This consequently alters Oliver’s demand. As illustrated in Figure 2-A, Oliver’s demand
for marijuana experiences an upward shift due to the elimination of the risk of punishment
associated with state law enforcement (change in expectations) and the increase in availability.
As time passes into the short run, more and more legal suppliers enter the industry, further
increasing the availability of the product and further shifting the demand curve up. In addition,
these legal suppliers begin to develop competition amongst each other. As a result, the selling
price of marijuana begins to decrease because each of them is trying to attract customers, which
consequently makes marijuana more affordable for Oliver and further drives the upward shift of
his demand curve. Finally, if legalization influences all marijuana consumers in a similar fashion,
we will also likely see an aggregate demand shift upward (although not necessarily a shift
equivalent to that of Oliver).
17
Keep in mind that while all of this is happening, Oliver’s demand for marijuana from
illegal suppliers continues to decrease, until eventually in the long run, it no longer exists.
Moreover, if all marijuana consumers experience these same changes in tastes and expectations,
we will also likely see the same aggregate demand decrease for marijuana from illegal suppliers.
Post-Legalization – Illegal Supplier Behavior
Now, let’s look at the effects of legalization on the individual illegal supplier. With the
news of legalization, Scott immediately experiences a change in expectations. First of all, Scott
realizes that his customers are going to start preferring to buy from legal suppliers because there
is no risk of state law enforcement. Scott also acknowledges the fact that he will now start to face
new competition with the addition of new (legal) suppliers. Moreover, Scott knows that his client
base will soon start to decline. In response to these expectations, Scott will immediately begin
attempting to sell the rest of his current supply stock. This is modeled in Figure 3-A, which
shows that Scott will increase his quantity supplied and price from point A to point B in an effort
to make a profit and avoid suffering a loss.
18
As time passes into the short run, Scott begins to see his expectations come true and alter
more of his constraints. On the one hand, his client base continues to decrease, while at the same
time, more and more legal suppliers are entering the market and increasing competition. The
combination of these two factors on Scott’s business starts to become visible as he begins to see
that he is not only failing to sell as much as he used to, but he also is beginning to see his profit
decrease. This can be shown by looking at our original equation for Scott’s profit (Eqn. 1). While
his cost structure is unaffected, he is experiencing a loss of revenue because he is not selling as
much as he used to, thus lowering his profit. At this point in time or in the near future, Scott will
have to make one of three decisions: (1) attempt to stay in business, (2) obtain a supplier license
and become legal, or (3) abandon the marijuana industry altogether.
For the sake of argument, let’s assume Scott chooses the first option and tries to stay in
business. In order to do this, Scott must offer his customers a better deal than the legal suppliers
are offering. What makes this very difficult for Scott, as shown in Figure 3-B, is that as more and
more legal suppliers enter the industry, each legal supplier begins to steadily lower its selling
prices in an effort to attract customers and gain market share. Thus, Scott has no choice but to
either lower his price or substantially offer more quantity at that price in order to compete with
19
them. However, even if Scott chooses to lower his price to match the market at point C, he will
find that consumers will still prefer to buy from the legal suppliers because there is no risk of
state law enforcement.
Thus, Scott must offer an even better deal either by further lowering his selling price beyond
point C, or by dramatically increasing his output quantity at that price to point D. Note, though,
that in order for Scott to allow himself to distribute at point D, he supply curve must become
flatter. Taking these actions causes Scott’s revenue and profit to decrease even further—
eventually reaching his break-even point (TR=TC) and then eventually his shut-down point
(TC>TR). In the end, Scott will be forced to abandon his illegal business and either become legal
or get out of the industry all together.
Looking at Figure 4-A, we can understand how these effects are changing the structure of
Scott’s local marijuana market. As more and more legal suppliers enter the industry, this pushes
the marginal revenue curve toward the demand curve because the market is becoming more
competitive. Also in effect, consumer surplus is increasing due to the reduction in price, which is
also causing producer surplus and the deadweight loss to society to shrink. Eventually, in the
20
Long-run, the market will establish an equilibrium price and quantity that maximizes both
consumer and producer surplus, as well as eliminate the deadweight loss to society.
Moreover, this represents a transition from an oligopolistic marijuana market to a perfectly-
competitive marijuana market—which is shown in Figure 4-B.
Conclusion
Summary of Findings
To briefly sum up our model, we have seen that legalization will have easily-visible
effects on both consumption and supply within any criminalized state that chooses to do so. First
of all, from an individual consumer standpoint, we can expect an increase in demand, which will
21
likely lead to an increase in consumption. If all consumers within the state react in this same
manner, we can also expect an increase in both aggregate demand and aggregate consumption.
For the individual illegal supplier, legalization should lead to a decrease in revenue and therefore
a decrease in profit. As time progresses into the long run, he or she will inevitably be left with
only two options—to become a legal supplier or abandon the marijuana industry all together.
Implications
There are two key positive implications that arise from this model. First of all, this model
strongly suggests that the legalization of marijuana can lead to the addition of a significantly
profitable industry to a state’s economy. Secondly, this also strongly implies that legalization
would lead to an increase in the number of available jobs within the state.
Problems and Complications
Despite these implications, there are also several crucial problems and complications
present. First of all, even if a state does pass a legalization law, the Federal government has made
it very clear that it will ―vigorously enforce‖ federal drug laws—which is what U.S. Attorney
General Eric Holder announced before the vote on Proposition 19 took place in California
(Hoeffel). If the Federal government steps up and makes even more arrests, this could have a
serious impact on the success of a legalization policy.
One main problem with our model is that it fails to mention what happens to demand-side
consumption in the long-run—it merely shows what happens in the short run. One reason for this
is because no one knows. Demand fluctuates in all industries, which is why economists and
statisticians frequently try to predict trends in demand. One noteworthy possibility, which might
run contrary to popular belief, is that legalization could potentially lead to a decrease in
22
consumption in the long-run. One supporting example of this is the country of Portugal, which
decided to decriminalize all drugs back in the year 2001. Since doing so, marijuana use has
―plummeted‖ to only 10% of Portuguese adults, which is less than the proportion of regular,
cocaine-using Americans (The Week).
One popular claim that supporters of Proposition 19 made was that legalization would
lead to a decrease in crime rates. While our model does show support in favor of a decrease in
marijuana crime, it does not suggest anything about the overall crime rate. The main reason for
this is because our model fails to take into account the unpredictability of an illegal supplier. For
all we know, he or she could potentially choose to move up to supplying harder drugs such as
cocaine or heroin. Moreover, overall crime rates could potentially stay the same or even increase.
One possible negative implication with our model involves the issue of health risks. If
there are, in fact, definite negative health effects on users, then an increase in demand and
consumption would very likely lead to an increase in health risks—both for individual marijuana
users, as well as for the entire the population. However, at this point, research is still being
conducted that is investigating both the harmful and beneficial effects of marijuana on users.
Similarly, the model also fails to account for the uncertain social costs that result from marijuana
us—such as medical expenses and rehab costs, financial costs of enforcement, encroachment on
individual rights and freedoms, adverse effects of a criminal record on one’s employment
potential, and the impact of penalties on users.
Yet, another major problem with our model is that is does not definitely say whether or
not legalization would lead to a net economic benefit. This is because it fails to account for
possible effects legalization of marijuana could have on consumption in other industries such as
23
tobacco and alcohol. A 2001 study conducted by the Research Triangle Institute concluded that a
10% increase in cigarette prices would lead to a 5.4% decrease in total marijuana use (Farrelly).
In addition, the study concluded that there is a complementary relationship between marijuana
and cigarettes and that ―policies that are aimed at reducing cigarette use are likely to also reduce
marijuana use‖ (Farrelly). What we can also take form this is that if we were able to more
accurately determine the responsiveness of consumers to changes in marijuana prices (i.e. price
elasticity of demand), as well as marijuana’s cross-price elasticities with tobacco and alcohol,
then we would be able to better determine the potential net economic benefit (if any).
Marijuana policy has two goals: to minimize health and safety hazards associated with
use and to minimize the social costs and adverse individual consequences resulting from
attempts to control use (Single 457). In trying to satisfy these two goals, one of the most critical
decisions policy makers will be faced with is determining the optimal tax level of marijuana so
that the model can perform how it is meant to perform. One consideration that policy makers
also need to consider is that they draft a policy proposal that gives incentives toward illegal
suppliers to join the legal suppliers rather than move up to cocaine or heroin trafficking. Policy
makers must also make sure illegal production and distribution of marijuana remains enforced
within the state—and one difficulty that will arise is being able to distinguish between legal
marijuana and illegal marijuana.
Final thought
All-in-all, behavioral economic principles and theories have a lot to say about the effects
of legalizing marijuana. Therefore, in order to draft and implement successful policies, policy
makers must have a thorough understanding of how microeconomic theory works.
Annotated Bibliography
Caputo, Michael R. Ostrom, Brian J. ―Potential Tax Revenue from a Regulated Marijuana
Market.‖ The American Journal of Economics and Sociology; Volume 53, No. 4 (Oct.,
1994), pp. 475-490. <http://www.jstor.org/stable/3487191>
This was one of my more useful sources. It provided me with the basic
uncertainties surrounding variables such as price elasticity of marijuana. It also
helped me work through my logic and set up my model for supply and demand
theory.
Gonzales v. Raich. No. 03-1454. Supreme Court of the U.S. 6 Jun. 2005. Webpage. <
http://www.supremecourt.gov/opinions/04pdf/03-1454.pdf>
The actual U.S. Supreme Court document of the case. Was useful in discussing
the impact of the resulting 6-3 decision in favor of federal enforcement of drug
laws.
Hoeffel, John. "Holder Vows Fight Over Prop. 19." The Los Angeles Times. The Los Angeles
Times, 16 Oct. 2010. Web. 14 Nov. 2010.
<http://articles.latimes.com/2010/oct/16/local/la-me-marijuana-holder-20101016>.
This source quoted the U.S. Attorney General saying that he will ―vigorously
enforce‖ federal drug laws despite whether or not Prop 19 passes.
"How Much Money Can a Marijuana Grower Make?" MarijuanaBusinessNews.com - Your
Guide to Millions in the Marijuana Business. MarijuanaBusinessNews.Com, 2007. Web.
14 Nov. 2010.
<http://marijuanabusinessnews.com/how_much_money_does_a_marijuana_grower_mak
e.aspx>.
This article breaks down how much profit one could acquire if he or she was to
grow marijuana in a 10’x10’ room with 5 lights of 1,000 watts each, taking into
account many factors, including the costs of electricity for one year. It estimates
that under these conditions, one could potentially earn $118,000 in total sales for
one year with an annual electricity cost of $3000.
"Marijuana - Data." DrugWarFacts. Common Sense for Drug Policy, Sept. 2010. Web. 1 Nov.
2010. <http://www.drugwarfacts.org/cms/Marijuana#Data>.
This source provided reliable and up-to-date information about marijuana arrests
over recent years.
―Marijuana Facts from Drug War Facts.‖ DrugWarFacts. Common Sense for Drug Policy, Oct.
2010. Web. 1 Nov. 2010. < http://drugwarfacts.org/cms/files/Marijuana-Facts-from-
Drug-War-Facts.pdf >
This provides information regarding estimation attempts at finding the total
number of marijuana users in the U.S., whether or not marijuana use is increasing,
total enforcement costs, potential revenue from taxation.
Marijuana Inc.: Inside America’s Pot Industry. Dir. Trish Regan. Prod. CNBC. 2009. CNBC, 22
Jan. 2009. Website. Accessed 25 Oct. 2010.
<http://www.cnbc.com/id/15840232/?video=1185791780&play=1>.
This documentary was useful for information regarding Mendocino County’s
economic dependence on the marijuana industry.
Marijuana USA. Dir. Trish Regan. Prod. CNBC. 2010. CNBC, 8 Dec. 2010. TV.
This documentary provided a nice, last minute update to my project/paper. It
provided a broad, general overview of the ways in which the marijuana industry
has gone mainstream.
Miron, Jeffrey A. "Don't Buy the Hype on Pot Legalization." CATO Institute. 19 Oct. 2010.
Web. 4 Nov. 2010. <http://www.cato.org/pub_display.php?pub_id=12485>.
In this article, Jeffrey Miron predicts an additional $1.4 billion in tax revenue
resulting under Proposition 19.
Miron, Jeffrey A. Waldock, Katherine. ―The Budgetary Impact of Ending Drug Prohibition.‖
Washington, D.C.: CATO Institute, 2010. Webpage. <
http://www.cato.org/pubs/wtpapers/DrugProhibitionWP.pdf>
This source provided the most recent and widely accepted estimates of several
variables relating to the legalization of marijuana. The study estimated that
legalization would save roughly $41.3 billion per year in national government
enforcement expenditure and would yield a tax revenue of about $46.7 billion
annually if it were to be taxed at rates similar to alcohol and tobacco.
"Portugal's Unorthodox War on Drugs." The Week Magazine: Political News and Cartoons,
Current Events and Entertainment Online. The Week, 30 Sept. 2010. Web. 15 Nov.
2010. <http://theweek.com/article/index/207592/portugals-unorthodox-war-on-drugs>.
This article showed that marijuana use in Portugal following decriminalization
actually decreased.
"Proposition 19: The Regulate, Control, and Tax Cannabis Act of 2010." State Board of
Equalization (BOE) Legislative and Research Division, 2 Nov. 2010. Web. 27 Nov.
2010. <http://www.boe.ca.gov/news/pdf/Proposition%2019%20draft%20analysis.pdf>.
This contains both the contents of Proposition 19, as well as an analysis of the
resulting laws. It is a great place to look for additional information regarding the
content of Proposition 19.
Single, Eric W. ―The Impact of Marijuana Decriminalization: An Update.‖ Journal of Public
Health Policy; Vol. 10, No. 4 (Winter, 1989), pp. 456-466,
<http://www.jstor.org/stable/3342518>.
This article was useful in developing my behavioral model. It identified the dual goal of
marijuana policy and the general trade-off between reducing social costs and the costs of
enforcement.
"State By State Laws." National Organization for the Reform of Marijuana Laws (NORML). 7
Nov. 2010. Web. 27 Nov. 2010. <http://norml.org/index.cfm?Group_ID=4516>.
This interactive information source proved wonderful in finding the most up-to-
date information about state-to-state marijuana decriminalization laws.
Substance Abuse and Mental Health Services Administration. (2010). Results from the 2009
National Survey on Drug Use and Health: Volume I. Summary of National Findings
(Office of Applied Studies, NSDUH Series H-38A, HHS Publication No. SMA 10-
4856Findings). Rockville, MD.
This survey provided data that showed a large proportion of youths ages 12 to 17
who have ―easy‖ access to marijuana. It also estimated the increase in marijuana
use among young adults ages 18 to 25 from 2008 to 2009.
"The Constitution of the United States," Article 1, Section 8, Clause 5.
This represents the Commerce Clause that allows Federal laws to override state
laws.