A Behavioral Economic Approach to Measuring the

Economic Impact of the Legalization of Marijuana

Jeff Lee
ECON-490
Professor Wade Shilts
11-23-10
 Abstract

The debate about the legalization of marijuana is one of the most heated debates in the

United States today. In fact, it has been ongoing for decades. Whether it is on T.V., in

newspapers, in magazines or on the Internet—we are constantly being thrown statistics—such as

how much tax revenue it will generate if it were legalized and taxed, the total worth of the

marijuana industry, . One of the major problems associated with all of these claims is the fact

that the marijuana industry exists ―underground‖ because it is illegal under Federal Law.

Consequently, we are left with incomplete information and uncertainties regarding key economic

variables needed to make accurate projections—such as its price elasticity of demand and its

cross-price elasticities with tobacco and alcohol. A more effective, yet often overlooked

approach is to analyze the effects of legalization on individual behavior using microeconomic

principles and theories. By doing so, we can better predict both consumer and producer behavior,

and in turn, be able to draft and implement successful policies to achieve the goals we want.

Based on this analysis, it can be concluded that there will likely be an increase in consumer

demand and consumption in the short-run, as well as a decrease in revenue and profit for illegal

suppliers (leading them to either become legal or leave the marijuana industry). Moreover, if

aggregate demand and supply act in the same fashion, the marijuana market will be transformed

from an illegal, oligopolistic market into a legal, perfectly-competitive market.

Introduction

Background

The debate about the legalization of marijuana is one of the most heated debates in the

United States today. In fact, it has been ongoing for decades. Marijuana is now more engrained

in our society than ever before. Its presence is everywhere—it is grown in homes, backyards,

even national parks. Its cultivation has now spread to all 50 states (Marijuana USA) and many

local economies around the country financially depend on the marijuana industry. In Mendocino

County, located in northern California, the marijuana industry accounts for approximately two-

thirds of the local economy (Marijuana Inc.). In fact, it is widely accepted that this region of the

state represents the largest supply of marijuana in the country, which has contributed to the

region’s nickname of ―The Emerald Triangle.‖ Marijuana’s availability can be easily identified

throughout the country, even in middle schools. According to the 2009 National Survey on Drug

Use and Health, almost half (49.9%) of youths between the ages of 12 and 17 reported that it

would be ―fairly easy‖ or ―very easy‖ for them to obtain marijuana (SAMHSA). In addition, the

rate of current marijuana use among young adults between the ages of 18 and 25 is estimated to

have increased from 16.5% to 18.1% (SAMHSA).

Not only is marijuana the most widely used illegal drug on the market, but it is also the

nation’s leading cash crop and is widely considered to be one of the most profitable industries

that exists in America. One of the reasons for this is due to the large profit margins that one can

achieve after getting involved in the industry. One study conducted by Cliff Schaffer in 2007

estimated how much annual profit one could earn if he or she were to acquire a 10’x10’ room

with five lights of 1,000 watts each. The conclusion was that this would result in $118,000 in

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total sales per year with an annual cost of electricity of $3,000; thus yielding a net annual profit

of $115,000 (MarijuanaBusinessNews). With this kind of profit potential, it is easy to see why so

many people choose to overlook the risk of punishment and get involved in this lucrative

industry.

In 1973, Oregon became the first state to ever enact a decriminalization law. Today,

thirteen states have, to some extent, decriminalized marijuana (NORML). Looking across these

states, there are noticeable differences in how much marijuana each state legally permits a

twenty-one year old or older to possess at one time, as well as noticeable differences in the

severity of fines. In California, for example, it is legal for people twenty-one years of age and

older to possess up to 28.5 grams (about an ounce) of marijuana without arrest—instead, they

can only receive a maximum fine of $100. As a result of the enactment of decriminalization laws

such as these, the United States has experienced the rapid growth of medical marijuana

dispensaries. The total number of dispensaries are increasing in number each month, and in the

city of Denver, Colorado, there are now more medical marijuana dispensaries than there are

Starbucks Coffee Shops and liquor stores combined (Marijuana USA).

Despite state decriminalization laws, marijuana is still 100% illegal under Federal law

due to the Commerce Clause of the United States Constitution. Under this clause, Federal

authorities are permitted to prosecute any and all offenses of Federal laws (Constitution). In the

2005 case of Gonzales v. Raich, the U.S. Supreme Court ruled, with a vote of 6 to 3, in favor of

the opinion that even where persons are cultivating, possessing, or distributing medical cannabis

in accordance with state-approved medical cannabis laws, such persons are violating federal

marijuana laws and can therefore be prosecuted by federal authorities (Gonzales v. Raich). This

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ruling essentially placed federal marijuana laws above state marijuana laws and has ever since

fueled the tension between the violators of federal law and the authorities that catch them.

As a result of these laws, the Federal Drug Enforcement Agency (DEA) routinely targets

and arrests medical cannabis patients, as well as seizes medical marijuana and business assets of

growers and medical marijuana dispensaries. All together, there are hundreds of thousands of

marijuana-related arrests every year nationwide. The year 2009 saw 858,408 marijuana-related

arrests (51.6% of total drug arrests)—a 1.8% increase from 2008, which saw 847,863 marijuana-

related arrests (49.8% of total drug arrests)(DrugWarFacts). After coming across such high

numbers, is it out of line to want to know how much money is actually being spent enforcing

federal marijuana laws? What about figuring out how many total marijuana users there are in the

U.S.? Has usage of the drug been increasing in recent years? How much money in tax revenues

would our national economy gain if marijuana was to be legalized and taxed similarly to that of

alcohol and tobacco?

Two Critiques

So called ―answers‖ to questions like these are thrown around all the time–both in the

media, and on the streets. For example, the Substance Abuse and Mental Health Services

Administration estimated that in 2009, there were approximately 17 million ―current‖ users of

marijuana who claimed to have consumed the drug at least once per month over the entire year—

which accounts for about 7% of the population (Marijuana Facts). The organization also

estimates that the number of ―current‖ (i.e. monthly) marijuana consumers increased by 11.7%

from 2002 to 2009 (Marijuana Facts).

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 Most recently, Harvard Director of Undergraduate Studies Jeffrey A. Miron (PhD in

Economics) and Stern School of Business doctoral student Katherine Waldock conducted a study

to determine the overall economic impact of the legalization of marijuana. Their research was

published this year by the well-respected CATO Institute. They concluded that the legalization of

the drug would save roughly $41.3 billion per year in national government enforcement

expenditure (Budgetary Impact). They also concluded that if the drug were to be legalized and

taxed at rates similar to those of alcohol and tobacco, this would yield a national tax revenue of

about $46.7 billion annually (Budgetary Impact). These numbers are the most recent and widely-

accepted estimates of these two measures.

While it must be acknowledged that the pursuit of accurate estimates is a necessary and

respectable practice when required to determine essential, yet difficult-to-obtain figures, there

are two problems that result when these estimates are taken and used as facts within debates that

attempt to determine the impact of the legalization of marijuana. The first problem with

estimates like these is that they are based on a variety of incomplete information and

uncertainties, which consequently renders them almost useless when designing a marijuana

legalization law. Many forget the fact that the marijuana industry exists outside of the legal

framework—and because it does, there is so much information that we do not know because it

simply never gets documented in any way! No one knows exactly how many current users of

marijuana there are, nor does anyone know exactly how many illegal suppliers (growers and

non-growers) there are. No one even knows the exact net economic benefit of legalizing

marijuana.

In addition to these unknown numbers, we are also left with an abundance of nearly-

unquantifiable variables. For example, we do not know the exact per-unit price of marijuana,

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since it ranges from both state to state and from county to county across the United States. We

also do not know exactly how marijuana consumers respond to changes in price (i.e. the price

elasticity of demand), nor do we know its exact cross-price elasticity with tobacco or alcohol

(which is needed in determining the net economic benefit; the gain in marijuana tax revenue

must not be offset by unintended consequences that result in other industries). Other

uncertainties include the effect of marijuana consumption on one’s health and development (still

being researched), as well as the social costs of federal law enforcement.

The second problem that follows is that people and interest groups cite particular

―estimates,‖ which vary across all kinds of different news sources, and often skew them to reflect

their own personal bias either in favor or against marijuana legalization. Considering the extreme

partisan nature of the debate itself (i.e. the vast majority of people are either for or against it; few

are ―on-the-fence‖), we should be skeptical of the plausibility of the numbers we hear (Caputo).

The heated debate that surrounded the recent Proposition 19 bill in California is a great

illustration of these two problems. Had the bill passed, it would have made it legal, under state

law, for consumers twenty-one years of age and older to possess up to one ounce of marijuana

for personal consumption—without being arrested or receiving a fine (BOE). In general, both

supporters of the bill and those in opposition cited many common-themed arguments to support

their stance on the issue. One of the most common arguments made amongst supporters was that

the ―War on Drugs‖ is failing in that the costs of enforcement are far outweighing the benefits.

Yet, another common claim that was brought up frequently was that under Proposition 19,

California should expect to gain about $1.4 billion in additional tax revenue (Miron article:

Don’t Buy the Hype). Many supporters relied heavily on this one number to support their

stances, overlooking that it was, in fact, just an ―estimate‖ based on the limited information and

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uncertainties surrounding significant variable measurements. Simply declaring ―$1.4 billion‖

does not automatically end a debate, let alone even constitute a decent argument.

Many opponents of Proposition 19 also followed this habit with the popular claim that

legalizing marijuana would seriously threaten the health and safety of the general public. In

addition, many made the claim that the consumption of marijuana has severe health risks on the

individual and increases the social cost on those around that individual. While this too may seem

like an acceptable argument, it overlooks the fact that there are uncertainties regarding the effect

of marijuana consumption on the health of an individual user, as well as uncertainties about what

its actual social cost on society is (if any). Research is still being conducted on this issue—and

one key counterargument to the claim that marijuana is ―bad‖ for users is that the reason for the

existence of medical marijuana is because studies have shown that there are indeed some

identifiable medical benefits from marijuana. This argument too, however, is unclear because

these potential benefits are still being explored. In the end, the bill was placed on the California

statewide ballot, and on November 2nd, 2010, about 54% of the voters voted ―no‖ while 46%

voted ―yes.‖

A More Effective Approach

In response to the presence of limited data and uncertainties surrounding all sorts of

statistics regarding the effects of marijuana legalization, it can be argued that a more effective

approach to accurately determining the effects of legalization on the economy is to analyze it

using the principles of behavioral economic theory. By focusing on how individual consumers

behave, as well as on how individual illegal suppliers behave, we can create a step-by-step model

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that shows the theoretical effects of legalization on each of these two individuals, as well as the

theoretical implications these have on the entire market.

This project is not about promoting marijuana or declaring that it should be legalized. It is

not about spreading opposition to legalization. In fact, this project doesn’t even make any

definitive stance on either side, nor does it attempt to determine any numerical value associated

with potential economic benefits of legalization (if any). Instead, the goal of this project is to

provide as much of an unbiased perspective on the issue as possible, and in addition, take a more

original approach and focus on what microeconomic principles and theories have to say about

the effects of legalization. Such an approach will prove to be much more powerful and

worthwhile than spending a large amount of time attempting to accurately quantify particular

measurements that nearly impossible to accurately determine in the first place! Again, this is due

to our lack of sufficient information about an industry that mostly exists ―off-the-grid.‖

In addition, by observing and investigating all sorts of cause and effect relationships

within behavioral economic theories, our understanding of how the creation of a legal marijuana

market would work will substantially increase, and, in short, policymakers will be able to draft

more attractive and successful legalization proposals within their respective states.

The Behavioral Theory Model

Defining Legalization

Before attempting to create the model, it is essential to first clarify and define what is

meant by ―legalization,‖ as well as to identify the difference between legalization and

decriminalization. First of all, ―decriminalization‖ refers to the reduction of penalties associated

with being caught for possession. Such penalties include eliminating jail time sentences for first-

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time offenders, as well as eliminating criminal charges. Under decriminalization, however, it is

still illegal to sell or possess marijuana, unless you own a medical marijuana license approved by

the state. Even then, though, anything having to do with marijuana is still 100% illegal under

Federal law and probably will be for a long time.

Legalization, on the other hand, refers to the ability of the drug to be sold, regulated, and

taxed legally within its respective state. It means that anyone twenty-one years of age and older

can legally possess, within the state, a particular amount of marijuana for personal use only, with

or without a medical marijuana license. It is also legal for anyone twenty-one years of age and

older, living within the state, to start up his or her own small business within the industry—

granted he or she (1) becomes a licensed supplier, and (2) cooperates with the government in

making sure they government receives their tax money. However, keep in mind that despite the

passing of any state law legalizing marijuana, the drug will still be considered 100% illegal under

federal law no matter what.

Defining the Framework of the Model

For our model, we must first choose a location: we will assume that we are in the state of

Iowa, where marijuana is currently both criminalized and outlawed under both state and federal

laws. Next, we will use several basic behavioral economic principles and graphs to show what

the current situation (Pre-legalization) looks like for both an individual consumer (who we are

going to call: Oliver) and an individual illegal supplier (who we are going to call: Scott). We will

then use this to derive aggregate demand and aggregate supply curves and show what the overall

marijuana market looks like as it is now (Pre-legalization).

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 Then, we will introduce legalization into the model and show how this influences and

changes the behavior of both individuals (Post-Legalization). We will also derive the new

aggregate demand and aggregate supply curves, as well as show the impact of legalization on the

marijuana market overall—in the short run and in the long run. Furthermore, we will summarize

our findings and identify the implications, potential problems, and complications associated with

our model.

Pre-Legalization – Consumer Behavior

To begin to tell the story, we will use the concept of utility maximization, which states

that the goal of a consumer is to maximize his or her utility, or satisfaction, subject to a set of

constraints (factors that influence one’s consumption). In our example, when purchasing

marijuana, Oliver’s goal is to maximize his utility, or satisfaction, for marijuana subject to four

constraints: (1) his budget, (2) his perceived health risk, (3) his perceived risk of being caught by

both state and federal law enforcement, and (4) the availability of marijuana.

Now, let’s invent the scenario in which Oliver is looking to buy marijuana from an illegal

supplier. We will not need to specify his exact desired amount, nor are we going to provide a

range of prices from which he is willing to pay—both are irrelevant to this particular model.

Instead, what is relevant is how he chooses who to buy from. Before we can determine this, we

must first make six key assumptions. Our first assumption is that (1) Oliver has relatively easy

access to the drug. Our second assumption is that, in choosing between two illegal suppliers, (2)

Oliver will choose to make his entire purchase from one illegal supplier or the other—he will not

buy partial amounts from both. Thirdly, we will assume that (3) he will buy from the illegal

supplier who is offering the lowest price per unit—which calls for our fourth assumption that (4)

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there is little to no difference between the quality of each product (while this might not be the

case, we will make this assumption for simplicity). Fifth, we will assume that (5) if two illegal

suppliers are offering Oliver the same price per unit, then Oliver will be indifferent between

which of the two illegal suppliers to buy from. Lastly, we will assume that (6) the risk of running

into state and federal law enforcement is the same for all possible transactions.

One way we can model Oliver’s preferences is by graphing indifference curves, which

represent sets of bundles among which he is indifferent. Figure 1 shows three indifference curves

that reflect Oliver’s preferences outlined in these assumptions above. As you can see, he has

access to two illegal suppliers (note: these can be either growers or non-growers). Both the

quality and price of each product are also nearly identical (as evident in the near 1:1 slope of the

indifference curves), which suggests that Oliver sees the two products as nearly perfect

substitutes—which are defined as two goods that a consumer places equal value upon. The near

1:1 slope also takes into account that the risk of running into law enforcement is the same in each

case.

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 Next, we will derive Oliver’s basic demand curve in Figure 2. Note that the slope of the

demand curve is arbitrary, considering we lack information about his responsiveness to price

changes (i.e. price elasticity of demand). However, note that his demand curve is downward

sloping because it shows that the basic law of demand holds in our model—as price of the good

increases, Oliver’s quantity demanded goes down (and vice-versa). From this, we can derive a

theoretical aggregate demand curve by taking the sum of all the individual demand curves in the

market for illegal marijuana, which notably do not have all the same slopes.

Pre-Legalization – Illegal Supplier Behavior

Now, we can look at the supply side of the current market using Scott as our illegal

supplier of marijuana. We will start this analysis by claiming that the goal of an individual

supplier is to maximize his or her profits. Equation 1 shows how Scott’s profit is calculated: by

taking his total revenue minus his total cost, which is also equal to output price times output

quantity minus input price times input quantity.

(Eqn. 1) Π = TR – TC = [(Pout)(Qout)] – [(Pin)(Qin)]

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Similar to Oliver, Scott is also subject to a list of constraints. There are seven factors that

influence Scott’s distribution: (1) his available client base (i.e. the number/availability of

buyers), (2) input costs, (3) expectations, (4) technology, (5) weather, (6) perceived risk of

running into state and federal law enforcement, and (7) his competition (i.e. other illegal

suppliers around him).

Taking all of these into account, we can graph Scott’s individual supply curve in Figure

3. As you can see, his supply curve is upward sloping, which shows that the law of supply holds

in this scenario (i.e. Scott will tend to offer more of his product at a higher price). Similar to how

we derived the aggregate demand curve, we can derive the aggregate supply curve by taking the

sum of all the individual supply curves. To keep things simple, we will assume that the slope of

Scott’s supply curve is determined by some combination of his constraints. Also, we will not

develop a production function for two reasons. First of all, Scott could be either a grower or a

non-grower, and so since a production function would only apply to a grower, we will omit it to

keep things simple. Secondly, we will see later on that the production function would remain

unchanged after legalization, and so this is also why we will choose to leave it out of our model.

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 Now, tying everything we have together so far, we can graph what the current overall

marijuana market looks like—but before we can do that, we must first identify which type of

market best fits it. In microeconomics, we learn about three types of markets: monopolies,

oligopolies, and perfectly-competitive markets, as well as the basic features of each. To start off,

we will look at the market structure of a monopoly. The first main characteristic of a

monopolistic market is that it consists of one seller. Secondly, this one seller has the ability to

―set‖ their own selling price. As a result, they are able to set their price(s) so low that no one else

can compete, thus gaining market power and preventing other firms from entering the market

(one example would be Wal-Mart). On the other hand, a monopoly also has the ability to set

their selling price well above that which would maximize profit. As a result, they are able to

essentially gain profit on top of profit.

With this in mind, let’s look at how a perfectly-competitive market works. Firstly, it

consists of lots of sellers who are constantly in competition with one another. As a result of this,

each firm within this type of market structure become ―price-takers‖ in that they are forced to set

their price to whatever the market determines (if they try to charge above their competitors, they

will lose). Also, there are no barriers to entry in a perfectly-competitive market—thus allowing

for any new number of firms to enter the industry. Lastly, no one firm has ―market power‖

because the equilibrium price is set where price equals marginal cost.

Now, looking back on these two types of markets, which one better depicts the current

marijuana market? Of the two choices, a monopolistic market would be more accurate—

however, an even more accurate market structure would be that of an oligopolistic market.

Imagine being able to divide the entire country into small areas and look at the marijuana market

within each small area. While some areas might have one major supplier or a large number of

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small suppliers, most places will likely a few marijuana suppliers. Also, despite the fact that

these few suppliers are in competition with each other, each are still able to charge a little more

for their products than the level which would maximize their profits (MC=MR), largely because

they are in an illegal market (there are no ―rules‖ for them to follow).

Figure 4 shows what the current oligopolistic marijuana market might look like within

Scott’s small area. In the graph on the left are the marginal cost and marginal revenue curves,

and the point at which they cross represents the point at which Scott maximizes his profits. As

you can see, however, Scott is able to set his price at a level above that which would normally

maximize his profits, which essentially gives him market power. This makes sense, considering

the large profit margin potential that exists for any illegal supplier within the industry. Going into

more detail, the graph on the right shows what different sections of the graph signify. First of all,

it shows consumer surplus in the top triangle, which represents the utility that consumers receive

by being able to purchase marijuana for a price that is less than they would be willing to pay.

Note that the size of this consumer surplus area is less than it would be if Scott wasn’t able to

charge above his normal profit-maximizing point. Moreover, Scott’s market power allows him to

increase his producer surplus—the utility he receives by being able to charge a price higher than

the minimum price he would be willing to sell his marijuana for. Lastly, the triangle on the right

represents the deadweight loss to society, or in other words, the total surplus that is lost due to

the fact that this is an imperfect market.

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Post-Legalization – Consumer Behavior

Now, let’s introduce the legalization of marijuana into the equation and see how this

alters the individual consumer’s behavior. If marijuana is legalized, this has an immediate effect

on our individual consumer by altering Oliver’s constraints. First of all, Oliver’s third constraint

is reduced because he no longer has to worry about state law enforcement when he purchases

marijuana from a newly created legal supplier (assuming he buys within the legal limit). This

also changes his fourth constraint because legalization will increase the availability of marijuana

by adding another supply source. Both of these two constraint changes are modeled in Figure 1-

A, which models Oliver’s new indifference curves. If a legal supplier is factored into Oliver’s

decision making, Oliver will prefer buying from a legal supplier as opposed to an illegal

supplier. The new slope of the indifference curves reflects this: Oliver places more value on the

legal supplier’s marijuana because he is willing to give up a lot of marijuana from the illegal

supplier for a smaller amount of marijuana from the legal supplier.

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 This consequently alters Oliver’s demand. As illustrated in Figure 2-A, Oliver’s demand

for marijuana experiences an upward shift due to the elimination of the risk of punishment

associated with state law enforcement (change in expectations) and the increase in availability.

As time passes into the short run, more and more legal suppliers enter the industry, further

increasing the availability of the product and further shifting the demand curve up. In addition,

these legal suppliers begin to develop competition amongst each other. As a result, the selling

price of marijuana begins to decrease because each of them is trying to attract customers, which

consequently makes marijuana more affordable for Oliver and further drives the upward shift of

his demand curve. Finally, if legalization influences all marijuana consumers in a similar fashion,

we will also likely see an aggregate demand shift upward (although not necessarily a shift

equivalent to that of Oliver).

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 Keep in mind that while all of this is happening, Oliver’s demand for marijuana from

illegal suppliers continues to decrease, until eventually in the long run, it no longer exists.

Moreover, if all marijuana consumers experience these same changes in tastes and expectations,

we will also likely see the same aggregate demand decrease for marijuana from illegal suppliers.

Post-Legalization – Illegal Supplier Behavior

Now, let’s look at the effects of legalization on the individual illegal supplier. With the

news of legalization, Scott immediately experiences a change in expectations. First of all, Scott

realizes that his customers are going to start preferring to buy from legal suppliers because there

is no risk of state law enforcement. Scott also acknowledges the fact that he will now start to face

new competition with the addition of new (legal) suppliers. Moreover, Scott knows that his client

base will soon start to decline. In response to these expectations, Scott will immediately begin

attempting to sell the rest of his current supply stock. This is modeled in Figure 3-A, which

shows that Scott will increase his quantity supplied and price from point A to point B in an effort

to make a profit and avoid suffering a loss.

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 As time passes into the short run, Scott begins to see his expectations come true and alter

more of his constraints. On the one hand, his client base continues to decrease, while at the same

time, more and more legal suppliers are entering the market and increasing competition. The

combination of these two factors on Scott’s business starts to become visible as he begins to see

that he is not only failing to sell as much as he used to, but he also is beginning to see his profit

decrease. This can be shown by looking at our original equation for Scott’s profit (Eqn. 1). While

his cost structure is unaffected, he is experiencing a loss of revenue because he is not selling as

much as he used to, thus lowering his profit. At this point in time or in the near future, Scott will

have to make one of three decisions: (1) attempt to stay in business, (2) obtain a supplier license

and become legal, or (3) abandon the marijuana industry altogether.

For the sake of argument, let’s assume Scott chooses the first option and tries to stay in

business. In order to do this, Scott must offer his customers a better deal than the legal suppliers

are offering. What makes this very difficult for Scott, as shown in Figure 3-B, is that as more and

more legal suppliers enter the industry, each legal supplier begins to steadily lower its selling

prices in an effort to attract customers and gain market share. Thus, Scott has no choice but to

either lower his price or substantially offer more quantity at that price in order to compete with

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them. However, even if Scott chooses to lower his price to match the market at point C, he will

find that consumers will still prefer to buy from the legal suppliers because there is no risk of

state law enforcement.

Thus, Scott must offer an even better deal either by further lowering his selling price beyond

point C, or by dramatically increasing his output quantity at that price to point D. Note, though,

that in order for Scott to allow himself to distribute at point D, he supply curve must become

flatter. Taking these actions causes Scott’s revenue and profit to decrease even further—

eventually reaching his break-even point (TR=TC) and then eventually his shut-down point

(TC>TR). In the end, Scott will be forced to abandon his illegal business and either become legal

or get out of the industry all together.

Looking at Figure 4-A, we can understand how these effects are changing the structure of

Scott’s local marijuana market. As more and more legal suppliers enter the industry, this pushes

the marginal revenue curve toward the demand curve because the market is becoming more

competitive. Also in effect, consumer surplus is increasing due to the reduction in price, which is

also causing producer surplus and the deadweight loss to society to shrink. Eventually, in the

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Long-run, the market will establish an equilibrium price and quantity that maximizes both

consumer and producer surplus, as well as eliminate the deadweight loss to society.

Moreover, this represents a transition from an oligopolistic marijuana market to a perfectly-

competitive marijuana market—which is shown in Figure 4-B.

Conclusion

Summary of Findings

To briefly sum up our model, we have seen that legalization will have easily-visible

effects on both consumption and supply within any criminalized state that chooses to do so. First

of all, from an individual consumer standpoint, we can expect an increase in demand, which will
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likely lead to an increase in consumption. If all consumers within the state react in this same

manner, we can also expect an increase in both aggregate demand and aggregate consumption.

For the individual illegal supplier, legalization should lead to a decrease in revenue and therefore

a decrease in profit. As time progresses into the long run, he or she will inevitably be left with

only two options—to become a legal supplier or abandon the marijuana industry all together.

Implications

There are two key positive implications that arise from this model. First of all, this model

strongly suggests that the legalization of marijuana can lead to the addition of a significantly

profitable industry to a state’s economy. Secondly, this also strongly implies that legalization

would lead to an increase in the number of available jobs within the state.

Problems and Complications

Despite these implications, there are also several crucial problems and complications

present. First of all, even if a state does pass a legalization law, the Federal government has made

it very clear that it will ―vigorously enforce‖ federal drug laws—which is what U.S. Attorney

General Eric Holder announced before the vote on Proposition 19 took place in California

(Hoeffel). If the Federal government steps up and makes even more arrests, this could have a

serious impact on the success of a legalization policy.

One main problem with our model is that it fails to mention what happens to demand-side

consumption in the long-run—it merely shows what happens in the short run. One reason for this

is because no one knows. Demand fluctuates in all industries, which is why economists and

statisticians frequently try to predict trends in demand. One noteworthy possibility, which might

run contrary to popular belief, is that legalization could potentially lead to a decrease in

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consumption in the long-run. One supporting example of this is the country of Portugal, which

decided to decriminalize all drugs back in the year 2001. Since doing so, marijuana use has

―plummeted‖ to only 10% of Portuguese adults, which is less than the proportion of regular,

cocaine-using Americans (The Week).

One popular claim that supporters of Proposition 19 made was that legalization would

lead to a decrease in crime rates. While our model does show support in favor of a decrease in

marijuana crime, it does not suggest anything about the overall crime rate. The main reason for

this is because our model fails to take into account the unpredictability of an illegal supplier. For

all we know, he or she could potentially choose to move up to supplying harder drugs such as

cocaine or heroin. Moreover, overall crime rates could potentially stay the same or even increase.

One possible negative implication with our model involves the issue of health risks. If

there are, in fact, definite negative health effects on users, then an increase in demand and

consumption would very likely lead to an increase in health risks—both for individual marijuana

users, as well as for the entire the population. However, at this point, research is still being

conducted that is investigating both the harmful and beneficial effects of marijuana on users.

Similarly, the model also fails to account for the uncertain social costs that result from marijuana

us—such as medical expenses and rehab costs, financial costs of enforcement, encroachment on

individual rights and freedoms, adverse effects of a criminal record on one’s employment

potential, and the impact of penalties on users.

Yet, another major problem with our model is that is does not definitely say whether or

not legalization would lead to a net economic benefit. This is because it fails to account for

possible effects legalization of marijuana could have on consumption in other industries such as

22
tobacco and alcohol. A 2001 study conducted by the Research Triangle Institute concluded that a

10% increase in cigarette prices would lead to a 5.4% decrease in total marijuana use (Farrelly).

In addition, the study concluded that there is a complementary relationship between marijuana

and cigarettes and that ―policies that are aimed at reducing cigarette use are likely to also reduce

marijuana use‖ (Farrelly). What we can also take form this is that if we were able to more

accurately determine the responsiveness of consumers to changes in marijuana prices (i.e. price

elasticity of demand), as well as marijuana’s cross-price elasticities with tobacco and alcohol,

then we would be able to better determine the potential net economic benefit (if any).

Marijuana policy has two goals: to minimize health and safety hazards associated with

use and to minimize the social costs and adverse individual consequences resulting from

attempts to control use (Single 457). In trying to satisfy these two goals, one of the most critical

decisions policy makers will be faced with is determining the optimal tax level of marijuana so

that the model can perform how it is meant to perform. One consideration that policy makers

also need to consider is that they draft a policy proposal that gives incentives toward illegal

suppliers to join the legal suppliers rather than move up to cocaine or heroin trafficking. Policy

makers must also make sure illegal production and distribution of marijuana remains enforced

within the state—and one difficulty that will arise is being able to distinguish between legal

marijuana and illegal marijuana.

Final thought

All-in-all, behavioral economic principles and theories have a lot to say about the effects

of legalizing marijuana. Therefore, in order to draft and implement successful policies, policy

makers must have a thorough understanding of how microeconomic theory works.

23
 Annotated Bibliography

Caputo, Michael R. Ostrom, Brian J. ―Potential Tax Revenue from a Regulated Marijuana
Market.‖ The American Journal of Economics and Sociology; Volume 53, No. 4 (Oct.,
1994), pp. 475-490. <http://www.jstor.org/stable/3487191>

 This was one of my more useful sources. It provided me with the basic
uncertainties surrounding variables such as price elasticity of marijuana. It also
helped me work through my logic and set up my model for supply and demand
theory.
Gonzales v. Raich. No. 03-1454. Supreme Court of the U.S. 6 Jun. 2005. Webpage. <
http://www.supremecourt.gov/opinions/04pdf/03-1454.pdf>

 The actual U.S. Supreme Court document of the case. Was useful in discussing
the impact of the resulting 6-3 decision in favor of federal enforcement of drug
laws.
Hoeffel, John. "Holder Vows Fight Over Prop. 19." The Los Angeles Times. The Los Angeles
Times, 16 Oct. 2010. Web. 14 Nov. 2010.
<http://articles.latimes.com/2010/oct/16/local/la-me-marijuana-holder-20101016>.

 This source quoted the U.S. Attorney General saying that he will ―vigorously
enforce‖ federal drug laws despite whether or not Prop 19 passes.
"How Much Money Can a Marijuana Grower Make?" MarijuanaBusinessNews.com - Your
Guide to Millions in the Marijuana Business. MarijuanaBusinessNews.Com, 2007. Web.
14 Nov. 2010.
<http://marijuanabusinessnews.com/how_much_money_does_a_marijuana_grower_mak
e.aspx>.

 This article breaks down how much profit one could acquire if he or she was to
grow marijuana in a 10’x10’ room with 5 lights of 1,000 watts each, taking into
account many factors, including the costs of electricity for one year. It estimates
that under these conditions, one could potentially earn $118,000 in total sales for
one year with an annual electricity cost of $3000.
"Marijuana - Data." DrugWarFacts. Common Sense for Drug Policy, Sept. 2010. Web. 1 Nov.
2010. <http://www.drugwarfacts.org/cms/Marijuana#Data>.

 This source provided reliable and up-to-date information about marijuana arrests
over recent years.
―Marijuana Facts from Drug War Facts.‖ DrugWarFacts. Common Sense for Drug Policy, Oct.
2010. Web. 1 Nov. 2010. < http://drugwarfacts.org/cms/files/Marijuana-Facts-from-
Drug-War-Facts.pdf >
  This provides information regarding estimation attempts at finding the total
number of marijuana users in the U.S., whether or not marijuana use is increasing,
total enforcement costs, potential revenue from taxation.
Marijuana Inc.: Inside America’s Pot Industry. Dir. Trish Regan. Prod. CNBC. 2009. CNBC, 22
Jan. 2009. Website. Accessed 25 Oct. 2010.
<http://www.cnbc.com/id/15840232/?video=1185791780&play=1>.

 This documentary was useful for information regarding Mendocino County’s

economic dependence on the marijuana industry.
Marijuana USA. Dir. Trish Regan. Prod. CNBC. 2010. CNBC, 8 Dec. 2010. TV.

 This documentary provided a nice, last minute update to my project/paper. It

provided a broad, general overview of the ways in which the marijuana industry
has gone mainstream.
Miron, Jeffrey A. "Don't Buy the Hype on Pot Legalization." CATO Institute. 19 Oct. 2010.
Web. 4 Nov. 2010. <http://www.cato.org/pub_display.php?pub_id=12485>.

 In this article, Jeffrey Miron predicts an additional $1.4 billion in tax revenue
resulting under Proposition 19.
Miron, Jeffrey A. Waldock, Katherine. ―The Budgetary Impact of Ending Drug Prohibition.‖
Washington, D.C.: CATO Institute, 2010. Webpage. <
http://www.cato.org/pubs/wtpapers/DrugProhibitionWP.pdf>

 This source provided the most recent and widely accepted estimates of several
variables relating to the legalization of marijuana. The study estimated that
legalization would save roughly $41.3 billion per year in national government
enforcement expenditure and would yield a tax revenue of about $46.7 billion
annually if it were to be taxed at rates similar to alcohol and tobacco.
"Portugal's Unorthodox War on Drugs." The Week Magazine: Political News and Cartoons,
Current Events and Entertainment Online. The Week, 30 Sept. 2010. Web. 15 Nov.
2010. <http://theweek.com/article/index/207592/portugals-unorthodox-war-on-drugs>.

 This article showed that marijuana use in Portugal following decriminalization

actually decreased.
"Proposition 19: The Regulate, Control, and Tax Cannabis Act of 2010." State Board of
Equalization (BOE) Legislative and Research Division, 2 Nov. 2010. Web. 27 Nov.
2010. <http://www.boe.ca.gov/news/pdf/Proposition%2019%20draft%20analysis.pdf>.

 This contains both the contents of Proposition 19, as well as an analysis of the
resulting laws. It is a great place to look for additional information regarding the
content of Proposition 19.
Single, Eric W. ―The Impact of Marijuana Decriminalization: An Update.‖ Journal of Public
Health Policy; Vol. 10, No. 4 (Winter, 1989), pp. 456-466,
<http://www.jstor.org/stable/3342518>.

 This article was useful in developing my behavioral model. It identified the dual goal of
marijuana policy and the general trade-off between reducing social costs and the costs of
enforcement.
"State By State Laws." National Organization for the Reform of Marijuana Laws (NORML). 7
Nov. 2010. Web. 27 Nov. 2010. <http://norml.org/index.cfm?Group_ID=4516>.

 This interactive information source proved wonderful in finding the most up-to-
date information about state-to-state marijuana decriminalization laws.

Substance Abuse and Mental Health Services Administration. (2010). Results from the 2009
National Survey on Drug Use and Health: Volume I. Summary of National Findings
(Office of Applied Studies, NSDUH Series H-38A, HHS Publication No. SMA 10-
4856Findings). Rockville, MD.

 This survey provided data that showed a large proportion of youths ages 12 to 17
who have ―easy‖ access to marijuana. It also estimated the increase in marijuana
use among young adults ages 18 to 25 from 2008 to 2009.
"The Constitution of the United States," Article 1, Section 8, Clause 5.

 This represents the Commerce Clause that allows Federal laws to override state
laws.