Question

Currently, 11 states have legalized marijuana or cannabis for recreational use. Four more states, 1

including Arizona and New Jersey, are voting to legalize and tax recreational marijuana sales recently . The motivation for legalization includes allowing the government to use police resources against more serious crimes, removing illegal drug dealers, raising tax revenue, and treating addiction as a public health issue instead of a criminal issue.

Question 1

a. Taxing legal marijuana sales is attractive at a time when states are looking for ways to increase their

tax revenues. Illinois has collected more than $100 million in recreational marijuana tax revenue

2 since legalizing sales on Jan 1 this year .

Different states have different approaches toward taxing legal marijuana. Some states adopt an approach like a typical sales tax where the consumer pays a tax on the purchase price. For example, in Oregon, a consumer pays a tax of 17% of the purchase price.

Suppose the recreational marijuana market is perfectly competitive. Use a diagram to discuss the impact of the sales tax on marijuana in Oregon. (18%)

b. A major argument for legalization and taxation as a rational solution to illegal marijuana use is that

high tax would discourage users from consuming. Using over 23,000 actual transaction data,

3 economists have found that the price elasticity of demand for marijuana was about 0.70. Interpret

the price elasticity of demand. Is the demand for marijuana price elastic or inelastic? Does it make sense? If the government wants to reduce marijuana consumption by 20%, by how many percent the marijuana price must increase? (8%)

Answer 1

a) Impact of the sales tax on marijuana in Oregon

With no tax, the demand curve is D₁ and the supply curve is S₁. The imposition of sales tax on the consumers will shift the demand curve to the left by the amount of the tax to D2. When the tax is imposed, the price that the consumer pays must exceed the price that the seller receives, by the amount equal to the tax.

The equilibrium quantity is Q₂, the price paid by consumers is P₂ (including the tax paid to the government), and the price received by producers is P₂ – tax amount.

b)  the price elasticity of demand for marijuana was about 0.70

price elasticity of demand less than 1 indicates inelastic demand or low responsiveness to price changes i.e. a rise in price causes an increase in revenue for the seller.

The demand for marijuana price inelastic as price elasticity of demand is less than 1 which indicates that the percentage change in quantity demanded is less than the percentage change in price. The high tax increases the price to consumers, however, it did not discourage users from consuming.

If the government wants to reduce marijuana consumption by 20%, by how many percent the marijuana price must increase?

Given, Percantage change in Quantity demanded is -20%

the price elasticity of demand = 0.70

Using the formula,

price elasticity of demand = Percantage change in Quantity demanded / Percantage change in price

-0.70 = -20%/Percantage change in price

Percantage change in price = +28.6%

So, the marijuana price must increase by 28.6%