2 Short Answers & Problems Please be sure to show all your work for each calculation. 1. On January Ist, 2014, the state of Colorado was the first to legalize the recreational sale and use of marijuana. Products containing cannabis could only be sold by licensed retailers. Purchase and use were limited to those age 21 and older (there are also limits on how much someone could sell or possess at once). At the time, there was a huge amount of uncertainty about what would happen as a result of le- galization. Today, we can use Colorado's experience to understand some key issues about supply and demand, which can help inform today's debates about the regulatory issues surrounding marijuana. A few facts about the Colorado market prior to legalization that will be useful: Estimates suggest that around 400,000 people used marijuana each month prior to 2014, which is fairly consistent with surveys that suggest 9 14 percent of teens and adults use marijuana. Surveys also suggest that an average user consumes about 8.3 grams per month (although like other drugs, there is a very positively skewed distribution). Prior to legalization, Colorado users reported paying a pre-tax average of $7.98 per gram. And data from the present day suggests that just after legalization, demand increased by about 50 percent. (a) Draw a supply and demand graph that represents the marijuana market prior to the law change, labeling what you can given what you know about the market. If there are externalities in the market, represent them on the graph and explain what they are. Quantify the size of the market (amount of revenue). (10 points) (b) Immediately after legalization, Colorado only granted sales licenses to existing medical marijuana providers. This meant that in the short term, marijuana supply was basically fixed. A few months into 2014, the price of a gram increased by about 40 percent, and sales went up by 664,000 grams per month. Draw this short-term change in the market, and calculate the elasticity of supply. For now, ignore any marijuana taxes. (10 points)(c) After a couple years, the state issued many more sales licenses, which allowed new store openings and new growers to enter the market. Prices dropped to about $10.30 per gram before taxes. Draw the new market, including labeling the new quantity. Explain what happened, and how the size of the market changed relative to pre-legalization (you can assume nothing other than new entry changed relative to part B). (10 points) (d) Now, consider the fact that Colorado's various taxes on marijuana totaled about a 29 percent effective tax rate. If your answer in part C was without taxes, how much tax revenue did the state earn from adding the tax on the market in part C? How much was paid by consumers, and how much by suppliers? (10 points) (e) One paper estimates that the social cost of marijuana use is about $11/gram. This excludes systemic crime, so is perhaps a useful quantification of social costs without prohibition (though may not be perfect since it was in a different context and contains a lot of uncertainty). Suppose $11/gram is a reasonable estimate of the social costs of consumption. What are the social costs of the level of marijuana consumption in part D? Are those costs big or small relative to the size of the market? Compare the level of the tax to what would be socially optimal from an economic perspective. (10 points) (f) Given your answer in part E, is there an economic rationale for the age limit Colorado applied? Explain why or why not. Would your answer be the same or different if the age limit covered the same number of people but applied to the elderly? (5 points) (g) Currently, Colorado is experiencing record low marijuana prices; pre-tax prices are between $8 and #9 per gram. What do you think might explain the price drop? You can think about what may have happened as the COVID-19 pandemic slowed down, how marijuana policies in other states changed over time, how long-term market adjustments might differ from short-term adjustments, or other plausible changes. Be concrete about how and why your hypothesis could explain a big price drop. (5 points) (h) Colorado marijuana businesses are lobbying for lower taxes to help support their business in this time of lower revenue, and politicians are worried about the drop in tax revenue that comes with lower prices. Given all you have learned from this question, is lowering the tax rate a good idea on economic grounds? If so, explain why. If not, explain why not and propose a policy you think would be more justified on economic grounds. Be specific and explain your reasoning, including any limitations or concerns you have about the policy or policies you recommend. (10 points)