Blue smoke and seers: measuring latent demand for cannabis products in a partially criminalized market

Abstract

Cannabis, otherwise known as hemp or marijuana, is one of the nation’s fastest growing cash crops. In the late 1990s, proponents of legalization began a successful effort to decriminalize cannabis at the state level. By 2020, over half of the U.S. population will have the ability to purchase legal cannabis in their state of residence. Even in open markets, widely varying state laws and a patchwork of reporting make direct observation of consumer purchases impossible. Governments seeking tax revenue, businesses seeking reliable market indicators, and consumers wanting reliable suppliers all have an interest in filling this knowledge gap. We approach this question from a perspective of fundamental economics and describe a methodology to estimate demand for legal cannabis products across all 50 states. From these estimates, we construct a monthly index of demand for medical and adult-use products and find that the data illustrate (1) continual increases in demand since 2016; (2) significant product substitution, especially for alcoholic beverages; (3) emerging brand differentiation; and (4) the existence of far-reaching regulatory and tax obstacles in many states. We note that these obstacles often cause tax revenue to be substantially smaller (and the black market much larger) than anticipated.

Appendices

Appendix 1: Equations

Equation 1: Latent Demand Equation

$$D_{s,t} = f\left( {\hat{Y}_{s,t} ,p_{t} ,\varOmega_{t} ,\lambda_{s} } \right),$$

(1)

where D_s,t is the demand for the product among residents of state s, at time increment t; $\hat{Y}_{s,t}$ the income among residents of state s, at time increment t; p_t the relative prices of the product; Ω_t the costs, tax burdens, and risks involved in buying and selling the product; λ_s the consumer tastes for the product, among residents of state s.

Equation 2: estimated demand equation

$$\hat{D}_{s,t} = f\left( {\overline{Y}_{s,t} ,\overline{p} ,\overline{\varOmega } ,I(\hat{X}_{s,t} ,\hat{m}_{s,t} ,\hat{\hat{D}}_{s,t} )} \right);$$

(2)

where $\hat{D}_{s,t}$ is the estimated demand for the product among residents of state s, at time increment t; $\overline{Y}_{s,t}$ the trended income among residents of state s, at time increment t; $\overline{p}$ relative prices of the product, presumed to be constant during a limited time period; $\overline{\varOmega }$ costs, tax burdens, and risks involved in buying and selling the product, presumed to be constant during a limited time period; $I( \cdot )$ indicator function for estimation methods; $\hat{X}_{s,t} = \hat{X}(\lambda_{s,t} )$ the demand estimated from observed sales of substitute product X, (alcoholic beverages) among residents of state s, based on consumer tastes λ, λ_s consumer tastes for the product, among residents of state s; $\hat{m}_{s,t} = \hat{m}(\lambda_{s,t} )$ demand estimated from observed sales of substitute product m, (medical marijuana) based on consumer tastes λ; $\hat{\hat{D}}_{s,t}$ demand estimated from reported sales in state s, at time increment t.

Note: carets indicate observed or calculated variables; bars indicate variables presumed to be constant during a short time period, which may also be unobserved.

Equation 3: index construction

$${\text{AndCanIndex}}_{t} = \frac{{\sum\limits_{s} {\hat{D}_{s,t} } }}{{{\text{AndCanIndexBase}}_{{{\text{November}}2016}} }} \times 100;$$

(3)

where $\hat{D}_{s,t}$ estimated demand for residents of state s, at time increment t; AndCanIndexBase_November2016 the Level at November 2016.

Appendix 2: Figs. 1, 2, 3, 4

Fig. 2

Market adjustment after legalization: state experiences. Per Capita Recreational Cannabis Sales (Population 18+). Source: State reports and estimates by Anderson Economic Group

Fig. 3

AndCan Index Data—state demand for legal medical cannabis. Estimates reflect both latent and observed demand. Source: Analysis by Anderson Economic Group using methodology and data described in text

Fig. 4

AndCan Index—December 2019 release. Consumer Demand for Legal Cannabis Products in the United States. Source: Analysis by Anderson Economic Group using methodology and data described in text