Thursday, November 8, 2012

Some partial equilibrium thinking on state-level marijuana legalization

My disclaimer on this is that my argument here may not be original and it may not be right, because I don't know the literature and I only have a vague sense of the laws around pot.

On the other hand it may be both original and right, so here it goes.

Yesterday I was thinking about the impact of state-level legalization of pot. Normally we economists talk about this sort of thing in terms of the monopoly power of drug cartels that prohibition maintains. But there's surely a lot more to it than that. Specifically, I imagine that federal prohibition and prosecution of the drug war probably has its biggest effect on supply. FBI and DEA agents don't usually deal with users, after all. There's also a cost effectiveness issue: to be cost effective federal law enforcement has to go after the big guns which basically means focusing on restricting supply.

State drug enforcement, alternatively, has a bigger focus on demand. Local cops are the guys that pull kids over, etc. State drug enforcement probably also has supply effects, its true, but as a broad statement we could probably say that federal prohibition hits supply and state prohibition hits demand.

So what will legalization in Colorado and Washington do? If it impacts demand more than supply it could actually raise prices. We usually don't think in these terms - we usually figure legalization is going to lower prices. But the interplay of state and federal law could have the opposite effect.

There are two extensions of this simple model:

1. As I said, state policy obviously will have some supply effects. But they'd probably be the downstream supply effects - dealers and local guys that are a little higher up on the food chain. So there would be some squeezing of the profit margins at that stage and perhaps some increase in supply with legalization.

2. Higher prices are going to encourage growing pot at home - that's going to be the situation for a lot of those suppliers higher up on the supply curve. I assume the feds have gotten involved in this activity in the past, although perhaps not as vigorously as they've dealt with cartels and gangs. How the feds approach home growers in Colorado and Washington in the future is thus going to have an impact on the outcome. You may see a kink in the supply curve higher up due to home growers in these states just getting left alone. Or you may see a kink to the right if they get uniquely cracked down on.


  1. Colorado have legalized growing up to 6 plants at home for non-commercial use, FYI.

  2. Local police have a much greater impact on supply. It's incredibly difficult to impact demand, because it's incredibly difficult to catch. They might catch kids smoking in their cars every once in a while, but that might make up a couple of percentage points of total pot usage. What local police really do is find grows and slash them. It's not necessarily that effective either, but legalization makes it so that illegal growers no longer need to hide their grows in their garage and no longer need to use high-cost inputs to hide heat/smell, et cetera. It opens large outdoor grows up to greater competition, which should reduce the price of marijuana.

    1. I should mention that usually police don't charge users; it's hard to charge someone who is carrying a couple of grams of marijuana with more than a misdemeanor, and it's usually a slap on the wrist. The person is going to turn around and replace the couple of grams confiscated, because the price of weed isn't that high to begin with (well, I live in Southern California so it might be cheaper here than it is elsewhere).

    2. Well sure but arrest or confiscation is a pretty negative demand shock even if there are no charges at all!

      I'm assuming too that when people carry enough that they can get charged with intent to distribute, it's very likely that they have no intention of distributing it at all - it's for personal use. That would also be a demand side factor. I'm just assuming that - I don't know that world very well and it may not be true. Perhaps they really are suppliers.

  3. I've spoken to people involved in the production of marijuana in California and the impression I got is that production and distribution got much easier after CA legalized medical marijuana. Among other things, they've made greater investments in capital goods and land than they could have prior to the passage of the law in question. Of course, Obama reneging on his original policies towards pot has tempered things a bit, but they're still operating at a much greater scale with less spent on secrecy.

    So while you are right that demand was probably more affected than supply, my understanding is that the effect on supply was still significant. Of course, this is all based on anecdote so take it with as much salt as you feel is necessary.


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