A California legislative committee has voted to legalize marijuana, sell it through state liquor stores, and impose a $50 per ounce tax on it, as a way of solving the state's budget deficit problems. A study by the Rand Corporation reports that the street (retail) price of marijuana in California is $75 to $100 per ounce; however legalization is expected to reduce production costs.
If marijuana was legal, the commercial supply of marijuana in California would be given by: Ps=25+Qs or Qs=Ps-25, where Q is the quantity supplied in millions of ounces, and P is the price per ounce.
The demand for marijuana in California is given by: Pd=150-4Qd or Qd=37.5-0.25Pd
1) Graph the before tax supply and demand for marijuana, and work out the equilibrium price and quantity.
2) Suppose a $50 per ounce tax on marijuana is implemented. Using the fact that Pd=Ps+tax, substitute for Pd in the demand curve. Draw the after-tax demand curve in terms of Ps on your diagram from part (1).
3) Work out the after-tax quantity and prices. What is the economic incidence of a marijuana tax? How much revenue does it raise?
4) Redraw your diagram from part (1). Using the fact that Ps=Pd-tax, substitute for Ps in the supply curve. Draw the after-tax supply curve in terms of Pd on your diagram. Confirm that this gives you the same results as the method used in parts (2) and (3).
5) Marijuana - unlike alcohol or tobacco or gasoline - is a low maintenance plant that can easily be grown in one's backyard or a kitchen window. Suppose that, if marijuana is legalized, the marginal cost of home-grown marijuana (of equivalent quality to store-purchased) is constant at $55 per ounce. How does the existence of an untaxed, home-grown supply of marijuana change your analysis in part (4)? What happens to prices, quantities, and government revenue? Use a diagram to work out your answer.