Problem: The Province of British Columbia decides to legalize marijuana.1 It does so, however, under rather stringent conditions. First, it mandates that the price be C$10 per ounce (the marginal cost per ounce-including provincial taxes-to producers is C$3). Second, it restricts the business to two firms BC Stone Age and Reefer Madness. Suppose that, annually, there are ten million customers total at C$10/oz. Since we are talking about Canadians, we know that they will be law-abiding and not buy from unlicensed distributors (so there is no point in anyone else attempting to enter this business). With typical over-reaction, the United States closes the border between Washington and British Columbia, so there are no American customers.
(a) Suppose that British Columbia limits the two companies' advertising.
In particular, for one week each year each company can run a radio and tv ad campaign. The campaign costs C$3,000,000. If neither firm runs a campaign or if both run a campaign, they each get half the customers that year. If only one of the two runs a campaign, it gets 75% of the customers that year (and the other firm gets the remaining 25%. The two firms decide simultaneously whether or not to mount a campaign. In this strategic interaction, do the firms have a dominant strategy? If so, what is it?
(b) A person on the bc Marijuana Advertising Board offers to tip off Reefer Madness if bc Stone Age will be running a campaign before Reefer Madness must decide about mounting its own campaign. Is this valuable information? How does your answer relate to part (a)?
(c) To make up for the tax revenue lost due to the elimination of American tourism, British Columbia raises the tax on marijuana. Now each firm's marginal cost is C$9. How does that change your answer to (a) (if it does)?
(d) In 2008, Hillary Rodham Clinton becomes President and the Democrats regain control of both houses of Congress. As a consequence, the ban on Americans travelling to British Columbia is lifted (but at the same time, the State of Washington is permitted to legalize marijuana, so there is no change in demand for marijuana in British Columbia). This, in turn, leads bc to reduce the tax, so marginal cost returns to C$3. The province does, however, propose a ban on marijuana advertising. Would Reefer Madness and bc Stone Age favor or oppose such a ban? Why or why not?
(e) Dangers of Free Entry. Advertising is banned. British Columbia does, however, relax the restriction on the number of firms that can
enter. Now any firm can enter provided it pays a C$1 million fee per year. Assume that the firms in the marijuana business in British Columbia divide the demand evenly among themselves. How many firms sell marijuana annually in British Columbia? What is their annual profit?