Implications of marijuana purchase task based demand functions for optimal legal pricing of cannabis

Legalization of recreational cannabis use in Canada has prompted a wide array of new policy decisions to be made at all levels of government. Policies had to be designed and implemented to cover everything from the structure of production, distribution, and retail markets to zoning requirements governing the location of storefronts. Policies concerning price have proven particularly challenging due to a lack of observation data on price sensitivity of cannabis demand and the degree to which users are willing to substitute legal cannabis for illicit cannabis and other drugs.

The most rigorous estimates of demand elasticity to date are derived from a sample of 289 cannabis users in Ontario who completed a hypothetical marijuana purchase task (Amlung & MacKillop, 2019). We calculate the optimal price of legal cannabis given a fixed illicit price based on this demand system for a range of parameters around the point estimates provided.

Our results clearly show a dichotomy between minimizing social harms and maximizing government revenue from legal cannabis net of production costs and social harm. In all cases the social harm minimizing legal price was below the illicit price while the net-revenue-maximizing price was above the illicit price.

The existence of the illicit market must be considered when designing legal cannabis pricing policies as it limits the effectiveness of price increases in controlling demand. Legal cannabis prices in Canada have so far been more consistent with revenue maximization than with minimizing social harms.