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

As the sales tax, t, is imposed, Marginal cost increases to MC+t and the quantity demanded of Marijuana reduces by more than the amount of the tax. Hence, it has a positive impact on the quantity reduction, achieving the aim of the taxation policy. Also, since it is a competitive market, MC curve is taken as a horizontal line equal to P.

2. Since price elasticity of marijuana is 0.70 which is less than 1, the price elasticity of demand is inelastic i .e. the demand for marijuana is steep. The percentage change is quantity demanded will be less than the percentage change in price. Hence, taxation policy might not be that fruitful in reaping the benefits when the demand is inelastic. It partially makes sense because marijuana is a drug and consumers would purchase it irrespective of its price and hence the price reduction will not be as anticipated and change in quantity would be less than the price. Government along with taxation has to adopt policies to bring a change in the consumer habits and preferences.

To bring a reduction of 20% in marijuana consumption, price increase has to be more than 20% as the demand for marijuana in price inelastic.