there is a constant marginal cost of $5 per ounce for growing
marijuana and delivering it to buyers. But whenever the marijuana authorities find
marijuana growing or in the hands of dealers, they seize the marijuana and fine the
supplier. Suppose that the probability that marijuana is seized is 0.3 and that the fine if you
are caught is $10 per ounce. Dealers are price takers.
a. If the “street price” is P per ounce, what is the expected revenue net of fines to a dealer
from selling an ounce of marijuana? And what is the equilibrium price of marijuana?
b. Suppose that the demand function for marijuana is the equation Q = 100 − P. If all
confiscated marijuana is destroyed, what will be the equilibrium consumption of
marijuana? Suppose that confiscated marijuana is not destroyed but sold on the open
market. What will be the equilibrium consumption of marijuana?

c. If there were increasing rather than constant marginal cost in marijuana production, do
you think that consumption would be greater if confiscated marijuana were sold than if it
were destroyed?

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