Application Assignment 1: Price Elasticity of Demand

Recreational marijuana was legalized in the state of Washington in July of 2014 creating a new source of revenue for the government. July 1, 2015, the state government raised excise taxes paid by marijuana retailers on final sales leading to the following effects on prices and quantity sold:

Effects on prices and quantity of marijuana sold in Washington, June and August 2015

Date Quantity Sold (average grams per day) Price (per gram)

June 2015 (pre tax change) 310.0 13.18

August 2015 303.1 13.48

The above example is adapted from a recent study into the effects of an increase in taxes on the marijuana market in Washington (Hansen, Miller, & Weber, 2017). The authors can estimate the price elasticity of demand from these data points because the sudden tax change created a ceteris paribus situation, where all other supply and demand conditions were held fixed, similar to the way our models assume in the textbook.

1.Comparing June 2015 to August 2015, using the arc formula for price elasticity of demand: What is the price elasticity of demand? If the business didn't have to pay the sales tax to the government, what affect would the price increase have had on their revenue?

2.All else equal, what would you expect to happen to the price elasticity of demand if there were an additional increase in taxes. Why?