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Sunday, October 31, 2010

Local pot growers fear being edged out of market with Prop 19

California voters are faced with many important decisions to make when voting on propositions this November, in particular proposition 19. Prop 19 would legalize growing and consumption of marijuana in California for non-medicinal use. While there are varying opinions on this proposition, the predominant economic justification for prop 19 is that it will allow local and federal governments to tax marijuana sales, with estimated tax revenue of $1-2 billion per year, in California alone.

In analysis of this proposition, I assume that there will be two markets that develop: The legal, taxable market, and the illegal, non-taxable, black-market. While the product that is supplied in each market is basically identical, the two market products will be considered substitutes.

If this proposition were passed in California, there could be a significant change in the legal marijuana market (which currently only exists for medicinal users). The supply curve for legal marijuana will likely shift outward. I believe this will occur considering there is a relatively low entry barrier for a supplier to enter this market (labor, equipment, and license). There will likely be a large amount of prospective suppliers entering the market in California, including some suppliers who previously operated in the black market. Additionally there will likely be an outward shift in demand for legal marijuana, as consumers who were previously obtaining it illegally decide to avoid the legal risk of obtaining marijuana through the black market. As the demand and supply shift outward, quantity demanded will increase and price will stay relatively similar, depending on how much each curve shifts relative to each other.

Conversely, in the substitute black market, with users switching from illegal to legal marijuana, there could be an inward shift in demand for illegal marijuana. There will likely be an inward shift in supply also, as some suppliers (at least the California based ones) choose to operate in the new legal market without previous legal ramifications. So based on these assumptions, quantity supplied will decrease, price remaining constant, initially.

I believe that initially there will be a shift in consumers “taste”, many consumers will opt to go the legal route, and obtain marijuana legally. As this occurs, there will likely be a reaction by black-market suppliers, not wanting to lose market share and revenue; consequently the price for illegally supplied marijuana will drop. Considering the legal and black-market marijuana goods are substitutes, some consumers will shift back to consuming black-market marijuana. These two markets will battle back and forth until equilibrium is attained.

The most important factor in these two competing markets that I have yet to address is taxation. The legal marijuana market is subject to sales tax, the black-market is not. As these two markets compete, the price of marijuana will indubitably go down, but the fact of the matter is that legal marijuana suppliers still would have to supply at a price that reflects tax. This is an added cost of production, which normally would be burdened by the consumer, but considering the consumer would have the option to buy a “legal” good at a price that does not reflect a tax in the black-market, there could be an incentive for consumers to obtain “legal” marijuana illegally.

The legal consequences of selling marijuana illegally would essentially be tax evasion. Some legal suppliers may choose to forgo taxation and operate illegally. If this occurs with a large proportion of suppliers, then the function of legalizing marijuana in order to boost tax revenue is essentially irrelevant.

Can the government effectively monitor and regulate marijuana distribution? Because it may cost more money to police distribution of marijuana than it’s taxation generates.

I'm not sure why you think there would still be a black market?

Do you see any sources of market failure with respect to a free, legal marijuana market?
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