Out of the shadows: the behaviour of the market for cannabis during its transition to legal status

ABSTRACT

This study considers the functioning of the market for recreational marijuana during its transition to legal status in Colorado and Washington State. Contrary to the expectation that moving from covert to legal status generates a freer flow of information that improves market functioning, we find that the measures we consider, price dispersion and the incidence of low-quality deliveries (‘rip-offs’), both show statistically and economically significant increases, reflecting worsening market functioning. We attribute this adverse outcome to the partial nature of the initial decriminalization, which maintained sanctions against selling, even while legalizing purchase and possession of small quantities. Our results also confirm that purchases increased with decriminalization. An influx of unsophisticated new buyers would create a less-informed average customer; a less-informed customer pool is consistent with poorer market outcomes, especially when dealers must continue to keep transactions secret. This work contributes to the empirical price dispersion literature, providing results consistent with the hypothesis that price dispersion increases when participants are less informed, but inconsistent with the prediction that price dispersion decreases with lower cost of price information. It also provides further evidence consistent with the importance of ‘rip-off’ transactions that has been highlighted in the literature on covert markets.

KEYWORDS:

• Price dispersion
• illegal markets
• search and learning
• information and product quality

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ Characterization of price distributions generated by product differentiation, such as Cohen (1998), is a distinct topic. The effect of price information and its accessibility seems to be the key issue here.

² We are grateful to an anonymous referee for this suggestion.

³ Mace, Patel, and Seegert (2020) and Vincent et al. (2017) find that price sensitivity is high among sophisticated purchasers (legal retailers and cannabis conference attendees respectively).

⁴ Very few transactions (3.8%) are reported as low quality suggesting such purchases are anomalous, not the result of an intention to consume low quality. This frequency of rip-offs is similar to that reported by Galenianos, Pacula, and Persico (2012).