In many ways, markets for legal marijuana are no different from other markets, but there is a risk that over-regulation can lead to a split market in which non-legal suppliers do not immediately disappear

1. Economics for your Classroom
Ed Dolan’s Econ Blog
The Economics of
Legal Marijuana Markets
July 9, 2014
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2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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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