Some partial equilibrium thinking on state-level marijuana legalization

My disclaimer on this is that my argument here may not be original and it may not be right, because I don't know the literature and I only have a vague sense of the laws around pot.

On the other hand it may be both original and right, so here it goes.

Yesterday I was thinking about the impact of state-level legalization of pot. Normally we economists talk about this sort of thing in terms of the monopoly power of drug cartels that prohibition maintains. But there's surely a lot more to it than that. Specifically, I imagine that federal prohibition and prosecution of the drug war probably has its biggest effect on supply. FBI and DEA agents don't usually deal with users, after all. There's also a cost effectiveness issue: to be cost effective federal law enforcement has to go after the big guns which basically means focusing on restricting supply.

State drug enforcement, alternatively, has a bigger focus on demand. Local cops are the guys that pull kids over, etc. State drug enforcement probably also has supply effects, its true, but as a broad statement we could probably say that federal prohibition hits supply and state prohibition hits demand.

So what will legalization in Colorado and Washington do? If it impacts demand more than supply it could actually raise prices. We usually don't think in these terms - we usually figure legalization is going to lower prices. But the interplay of state and federal law could have the opposite effect.

There are two extensions of this simple model:

1. As I said, state policy obviously will have some supply effects. But they'd probably be the downstream supply effects - dealers and local guys that are a little higher up on the food chain. So there would be some squeezing of the profit margins at that stage and perhaps some increase in supply with legalization.

2. Higher prices are going to encourage growing pot at home - that's going to be the situation for a lot of those suppliers higher up on the supply curve. I assume the feds have gotten involved in this activity in the past, although perhaps not as vigorously as they've dealt with cartels and gangs. How the feds approach home growers in Colorado and Washington in the future is thus going to have an impact on the outcome. You may see a kink in the supply curve higher up due to home growers in these states just getting left alone. Or you may see a kink to the right if they get uniquely cracked down on.