Question

In the city of Los Locos, marijuana producers have a marginal cost of $10 per ounce for growing expenses. Under the current law it is illegal to sell marijuana. The city police seize 20% of all marijuana grown and impose a fine of $20 per ounce. Los Locos is considering legalizing marijuana, and wants to impose a tax that would leave total consumption unchanged. The city should impose a tax of
100%? 50%? 150%? 25%? 75%?

Answer 1

Consider a case when demand for a good increases and supply of good decreases simultanoeusly

An increase in demand and a decrease in supply will cause an increase in equilibrium price, but the effect on equilibrium quantity cannot be deter mined. For any quantity, consumers now place a higher value on the good,and producers must have a higher price in order to supply the good; therefore, price will increase. The effect on output will depend on the relative size of the two changes.

There will be 3 cases

decrease in supply > increase in demand equilibrium quantity will fall

decrease in supply = increase in demand equilibrium quantity will remain unchanged

decrease in supply < increase in demand equilibrium quantity will rise

The second case is of our interest

Legalizing of marijuana increases demand for marijuana

Imposition of tax will decrease of supply of marijuana

Change in demand and supply should be equal from both these events to ensure total equilibrium quantity remains unchanged