Question

Suppose marijuana has just been legalized in your state. Nobody in your home town wants to start a marijuana business, as this would be too much of a stigma. But being an MBA student, you know a good business opportunity when you see one and decide to take a stab. Shortly after starting up your business, you gain a loyal following of customers and start raking in some steep profits. However, the local government decides that they want a cut of your profits and starts charging a 20% sales tax on marijuana. Do you think this would lead to a 20% or greater loss in sales? Do you think marijuana in this situation would be facing inelastic or elastic demand? Explain your reasoning, and make sure to cite at least one of the required readings regarding elasticity.

Answer 1

Marijuana is legalized, but for its medicinal and healthcare uses. It is not utilized for its direct consumption as a narcotic drug. Due to increase in sales tax of 20%, price of the marijuana will also be increased by 20%. But, it will not reduce the demand of marijuana by 20%. It will not happen because the demand of marijuana is relatively inelastic and it is already proved by the research (Davis & Nichols, 2013) that it ranges between -.3 to -.6. It means that with a 10% increase in price, demand comes down in the range of 3% to 6%. It shows that the demand is relatively inelastic in nature.

Due to its medicinal benefits, acute need of marijuana as medicine and physician's prescription, cause patient to buy the marijuana based medicines. It makes it to be relatively inelastic.

Reference:

Davis, A.J. and Nichols, M.W. (2013).The Price Elasticity of Marijuana Demand. Department of Economics, UNR Economics Working Paper Series Working Paper No. 13-004.