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PRICING AND PACKAGING:
THE CASE OF MARIJUANA
by
Kenneth W Clements
*
Economics Program
The University of Western Australia
Abstract
In many markets unit prices decline as the quantity purchased rises, a phenomenon
which can be considered to be part of the economics of packaging. For example, in
Australia marijuana costs as much as 80 percent less if purchased in the form of ounces
rather than grams. This paper reviews the economic foundations of quantity discounts and
proposes new ways of measuring and analysing them. These ideas are implemented with
the prices of marijuana, a product that is shown to be priced in a manner not too different
to that used for groceries and other illicit drugs. In broad terms, the results support the
following pricing rule: The unit price falls by 2.5 percent when the product size increases
by 10 percent.
*
I would like to acknowledge the research assistance of Mei Han, Lisa Soh and Katherine Taylor, and the
helpful comments of Larry Sjaastad, MoonJoong Tcha, Lester Telser and Darrell Turkington. I also
acknowledge the considerable trouble that Gordon Mills went to in providing me with his unpublished
survey data on grocery prices. This research was financed in part by the Australian Research Council.
2
1. INTRODUCTION
Over the 1990s in Australia, the average price of a gram of marijuana was about
$A35, while an ounce cost $449. As there are 28 grams in an ounce, this means that the
per ounce cost of a gram was 28 × 35 = $980, or more than twice the cost when marijuana
was purchased in the form of an ounce. Put another way, there is a substantial discount
for purchasing marijuana in bulk, or a premium for smaller purchases. This paper deals
with the measurement and understanding of these sorts of quantity discount.
One explanation for the phenomena of quantity discounts is the role of risk. Suppose
a dealer has, say, ten ounces of marijuana to sell and is faced with the alternative of
making either ten individual sales of one ounce each, or 280 gram sales. The latter
marketing strategy could possible run the risk of greater exposure of the illicit drug
operation. If the dealer has contact with a larger number of people, this could possibly
increase the risk of apprehension, increasing the expected value of a penalty from the
justice system. More generally, as the activities of larger dealers could possibly be more
hidden from the law, they do not have to spend so much investing in “security”. On the
other hand, dealers on the street may have to either bribe police or engage in expensive
security arrangements to be able to stay in business. Sjaastad (2003) argues that “[t]he
gangs here in Chicago, which dominate the drug trade, maintain rather expensive
organisations to keep them in motion and they face a lot of competition as there is free
entry into the street business. On the other hand, the bulk dealers are likely to be part of a
cartel, which has no competition.” These considerations all lead to the unit cost of illicit
drugs increasing as the size of the sale falls.
A completely different explanation of quantity discounts involves the value added
as the product moves through the supply chain. The “conversion” of marijuana from
ounce to gram lot sizes is not a costless operation, and can be thought of as analogous to
the economic role played by any retailing business such as a service station which sells
petrol to motorists. The economic function performed by a service station is the
transformation of tanker loads of petrol into smaller lot sizes suitable for individual cars.
As this activity is valued by consumers, they are willing to pay for it in the form of petrol
prices at the bouser that are considerably higher than the wholesale price.
3
Accordingly, the quantity discount that the service station receives when it purchases
petrol from the wholesaler is its retail margin that simultaneously represents consumers’
valuation of the economic function it performs, as well as its value added. Thus to make
280 gram sales of marijuana, rather than ten sales of one ounce each, would be a more
costly way of marketing the product, due to the time and effort associated with splitting
ounces to grams, and the need to service a larger number of customers individually.
A third explanation of quantity discounts relates to pricing strategies of firms with
market power. In cases where larger buyers have a more elastic demand for the product
and resale can be prevented, then the discounts they receive may be a manifestation of
price discrimination by a powerful supplier. For arguments along these lines, see, e.g.,
Mills (1996, 2002).
This paper introduces new ways of measuring and analysing quantity discounts,
with an emphasis on the marijuana market. Section 2 explores in some detail alternative
approaches to the problem. Section 3 discusses the discounts available for purchasing
marijuana in bulk, while the concept of the “discount” is formalised in Section 4 in terms
of what we call the “size” and “discount” elasticities of prices. In Section 5 we present a
novel way of extracting estimates of the discount elasticity from the distribution of prices.
Sections 6 and 7 deal with the econometrics of packaging, and the procedures discussed
therein are implemented in Section 8 with marijuana prices. Section 9 considers pricing
practices in other markets, including groceries. Concluding comments are contained in
Section 10.
2. ALTERNATIVE APPROACHES TO PACKAGE PRICING
This section considers several different approaches to understanding aspects of the
economics of package pricing.
TwoPart Pricing
Consider a product whose price is related to the cost of its package size and the
volume of the product. Following Telser (1978, Sec. 9.4), let s denote the volume of the
4
product in the package, so that
3 1
s is proportional to the linear dimension of the
package and the square of this,
3 2
s , is proportional to the area of the package surface.
The cost of the contents of the package is proportional to the volume, s α , while the cost
of the packaging is proportional to the area,
2 3
s β . Suppose that as an approximation, the
price of a package of size s , p , is the sum of these two costs:
(2.1)
2 3
p = αs + s β .
The price per unit of the product is
(2.2)
1 3
p s = α + s β .
This shows that unit price declines with package size, as the package cost increases less
than proportionately to the volume of the product. The declining unit price result can also
be expressed in terms of the elasticity of price with respect to size. If this elasticity is less
than unity, then the per unit price falls. It follows from equation (2.1) that the effect on
package price of an increase in size is ( )
1 3
p s = α + 2β 3 s ∂ ∂ . Thus price increases
with size, but at a decreasing rate. Let η denote the size elasticity ( ) ( ) log p logs = ∂ ∂
( ) ( ) p s p s ∂ ∂ . It follows from the above expression for the marginal effect and
equation (2.2) for the corresponding average that the size elasticity takes the form
(2.3)
( )
1 3
1 3
α + 2β 3 s
η =
α + βs
.
As the numerator is clearly less than the denominator, the elasticity is less than unity.
Next, suppose there is a cost per transaction that is independent of the price and
package size. This fixed cost could be associated with the processing of the sale, and/or
other administrative expenses. Then, if γ is the fixed cost, equations (2.1) and (2.2)
become
5
2 3
p = γ + αs + βs , ( )
1 3
p s = α + γ 1 s + βs ,
and the size elasticity takes the form
(2.4)
( )
( )
1 3
1 3
α + 2β 3 s
η =
α + γ 1 s + βs
.
As there is an additional positive term in the denominator of (2.4), ( ) γ 1 s , the value of the
elasticity is now lower than before. This is because as the transaction cost is fixed, it is spread
over a larger base as size increases, and the proportionate effect of size on price is now lower.
A MultiStage Supply Chain
Consider an individual who purchases an ounce of marijuana and then splits it into 28
gram packets to sell. What can be said about the relationship between the ounce price and the
gram price? As the seller of ounces and grams may be the same person, we could consider the
relationship between the two prices to be determined by an arbitrage condition, according to
which the seller is indifferent between the form in which the product is sold. This issue has
wider applicability than to just the market for illicit drugs, as analytically exactly the same
considerations apply to packaging decisions pertaining to legal products, such as selling rice
by the kilo or half kilo. As for many products wholesale transactions involve larger volumes
than retail, the issue is also similar to the spread between wholesale and retail prices. We thus
proceed with some generality and consider a generic step in a multistage supply chain.
Let
i1
p be the price of a good sold at step i 1 − in the supply chain, such as the price of
an ounce of marijuana sold in the form of an ounce. Then if
i 1
q
−
is the corresponding
quantity,
i 1 i 1
p q
− −
is total revenue derived from step i 1 − . This revenue is to be compared to
the costs of selling
i 1
q
−
at step i 1 − . Suppose these are made up of material costs plus
processing and selling expenses; denote these costs per unit by c
i1
. Total cost is
i l i 1
c q
− −
,
and profit is
(2.5)
i 1 i l i l i 1
p q c q
− − − −
− .
6
Suppose at the next stage of the marketing chain the product is processed further and then
split such that the unit sold is now as a multiple
i
1/ s < 1 of that at the previous step. In
terms of the units at step i ,
i
s is the package size at the previous step; in terms of the units
at i  1,
i
1 s is the size at i . In transforming marijuana from ounces into grams at step
i
i, s 28 = . With
i
p the price at this step (dollars per gram), the profit from selling the same
quantity involved in (2.5),
i l
q ,
−
in the form of smaller units is
(2.6)
i i i 1 i i i l
p s q c s q ,
− −
−
where
i
c is the overall per unit cost at step i.
Note that
i 1
c
−
and
i i
c s are the costs of materials, processing and selling exactly the
same volume of the product at successive steps in the supply chain. If, for example, the only
cost were a constant fixed cost for each sale, then
i i 1
c c
−
= and
i i i  1
c s c > as
i
s > 1. But
this is an extreme case, and in all likelihood per unit cost would fall with the volume
transacted, so that
i i  1
c c < . It still seems reasonable however that this cost falls less than
proportionately than the quantity transacted
i
s , so that the cost per gram of marijuana when
sold in the form of ounces,
i 1 i
c / s
−
, is less than the same cost when sold in the form of grams
i
c . We shall thus assume that
(2.7)
i i i1
c s c > .
In words, the overall cost associated with one sale of an ounce of marijuana is less than that of
28 distinct sales of 1 gram each. If entrepreneurs have a choice regarding where in the supply
chain they locate, arbitrage will ensure that profits at each step are equalised. Thus equating
(2.5) and (2.6), we obtain
(2.8) ( )
i1 i1 i i i
p  c = s p  c ,
so that the netofcost price, appropriately adjusted for the differing quantities transacted, is
equalised at each step in the chain: The profit from processing and selling an ounce of
marijuana is equal to 28 times that of processing and selling a gram. Equation (2.8) has
7
several interesting implications. First, we write it in the form
i1 i i i i i1
p = s p  s c + c and
then in Figure 1 plot
i1
p against
i i
s p . The slope of the curve AB is 45º, while the slope of
a ray from the origin to any point on the curve, such as OC, is less as long as condition (2.7) is
satisfied. As the elasticity is the ratio of the slope of the curve to the slope of the ray, under
(2.7) the elasticity of the price at stage i1 in the chain with respect to the price at stage i
is greater than unity. Accordingly, the volatility of prices is amplified as we move back
through the supply chain. This agrees with the observation that retail prices of meat, for
example, are much more stable than livestock prices. More generally, agricultural prices at
the farmgate level generally exhibit more volatility than their retail counterparts.
FIGURE 1
PRICES AT TWO STEPS IN THE SUPPLY CHAIN
A second implication of equation (2.8) can be revealed if we write it as
( )( )
i i i i1 i1
p  c = 1 s p  c , or
(2.9) ( )( )
i i i1 i1 i
p = c + p  c 1 s .
We see that the price is the sum of a fixed cost per transaction plus a variable cost related to
the quantity in the package. Third, by successive substitution it is possible to use equation
(2.9) to express the price at any step in the supply chain in terms of the characteristics of all
previous steps as
45
o
A
C
B
Price at
step i1
p
i1
i1 i i i1 i i
p = s c + c + s p
i i i 1
s c c
−
−
Price at step
i i
i, s p
O
8
(2.10)
( ) ( )
n  1
i i i  n i  n i  k
k = 0
p = c + p  c 1 s
∏
,
where n is the number of steps in the chain before step i . Thus the price at step i
comprises (i) unit costs at this step and (ii) the price of the “basic” product, net of basic costs,
appropriately discounted to reflect the economic distance that the product has travelled up the
supply chain, away from its basic source. Equation (2.10) thus reveals how a shock to the
price at the basic level in the chain is transmitted to all higher levels. As it travels up through
the chain, such a shock has a dampened impact due to the splitting of the product at each step;
that is, as
( )
i  k
1 s < 1 for all k ,
( )
n 1
k 0 i k
1 s 1
−
= −
∏ . Consider the special case where the
product is divided by the same amount at each step, so that
i
s = s . If this were to describe
the operation of the marijuana supply chain, the volume transacted at successive steps would
be …
2
28 × ounces , 28 × ounces , ounces , grams . In this situation, the last term on the
righthand side of equation (2.10) simplifies to
( ) ( )
n
n 1
k 0 i k
1 s = 1 s
−
= −
∏ .
Finally, equation (2.8) has implications for the nature of quantity discounts. Consider
again the case of marijuana with processing of ounces into grams. The term
i 1
p
−
is then the
price if we buy an ounce of marijuana in the form of an ounce, while
i i
s p is the cost of the
same quantity if purchased in the form of 28 lots of gram packages. Accordingly,
( )
i1,i i1 i i i i
d p  s p / s p ≡ is the proportionate quantity discount available in the transition from
step i1 to i . It follows from equation (2.8) that the discount takes the form
( )
i 1,i i i 1 i i
d c c c s 1 ,
− −
′ = − where
i i i
c c / p ′ = is the proportionate cost at step i . Condition
(2.7) implies that
i1, i
d < 0 . If we write the discount as a function of the package size,
( )
i 1,i i
d f s
−
= , then f < 0 ′ and f > 0 ′′ . In words, as the package size rises, the discount
increases (in absolute value), but at a decreasing rate. The relationship between the size
elasticity and quantity discounts will be discussed subsequently in Section 4.
9
A related way of modelling the operation of the marketing chain, which does not rely on
an arbitrage condition, is as follows. In the above formulation the unit cost
i
c represents the
costs of materials, processing and selling at step i . A component of this overall cost is the
cost of the product at the previous step. We now decompose the overall cost into the cost of
the product used as input,
i  1 i
p s , and “other” costs
i
c , so that
i i i  1 i
c = c + p s . If
i
δ
is the markup factor at stage i , then the price is linked to costs according to:
(2.11)
( )
i i i i  1 i
p = δ c + p s .
As
i
δ and
i
c in equation (2.11) are both positive, the elasticity of
i
p with respect to
i  1
p
is less than unity. This amounts to the elasticity of
i  1
p with respect to
i
p being greater
than unity, the same result as before; see the discussion below equation (2.8).
1
A LogLinear Model
Caulkins and Padman (1993) propose a model which gives some further insight into the
relationship between price and package size. In particular, their approach relates the size
elasticity of price to some more basic features of the packaging business. This subsection
sets out this approach.
Suppose there is a loglinear relationship between price and package size,
logp = α + βlogs ′ , where α ′ is an intercept and β is the size elasticity. Writing p(s)
for price as a function of size, we have
(2.12) ( )
β
p s = αs ,
where α = exp(α ) ′ . Suppose that initially an ounce of marijuana is purchased and that we
1
Equation (2.11) has on the lefthand side the price in terms of the unit transacted at step i (such as dollars per
gram), while on the right is the price at the previous step in terms of the same unit (the ounce price expressed in
the form of dollars per gram). Thus, (2.11) could be considered as a firstorder difference equation in the price
measured in a common unit. It is therefore tempting to analyse the solution to this equation and declare that the
natural end to the supply chain occurs when the price hits its steadystate value of ( ) δc 1  δ . But such an
approach is misguided as the steadystate is never reached because the markup δ is presumably always greater
than unity. One alternative way of proceeding would be to treat the markup as endogenously determined such
that the chain ends when δ falls below unity as a result of the forces of competition.
10
measure size in terms of grams, so that s = 28 and p(28) is the price of this ounce. If this
ounce is then split into 28 gram packages, so that s = 1 now, the revenue from these 28
packages is 28 × p(1) , where p(1) is the price of one gram. Define the ratio of this
revenue to the cost of an ounce as the markup factor, δ = 28 × p(1) p(28) , or
28 × p(1) = δ × p(28) . More generally, let > 1 φ be the conversion factor that transforms
the larger quantity s into a smaller one s φ; in the previous example = 28 φ . Thus we
have the following general relationship between prices of different package sizes, the markup
and conversion factors:
(2.13) ( )
s
× p = δ × p s
 
φ

φ
\ .
.
Our objective is to use equations (2.12) and (2.13) to derive an expression for the size
elasticity β that involves the markup and conversion factors δ and φ . To do this, we use
equation (2.12) in the form ( ) ( )
β
p s = α s φ φ , so that the lefthand side of equation (2.13)
becomes ( )
β
α s φ φ . Using equation (2.12) again, we can write the righthand side of (2.13)
as
β
δαs . Accordingly, equation (2.13) can be expressed as ( )
β
β
s / = δs φ φ , or
( ) 1β
= δ φ ,
which implies
(2.14)
logδ
= 1 
log
β
φ
.
Equation (2.14) shows that the size elasticity falls with the markup δ and rises with the
conversion factor φ . If there is no markup, 1 δ = and the size elasticity 1 β = , so that
price is just proportional to package size and there would be no quantity discount for buying
in bulk. When 1 δ > , the unit price falls with the quantity purchased, so that discounts
would apply. As the markup rises, so does the quantity discount and the (proportionate)
increase in the total price resulting from a unit increase in package size is lower. In other
words, the size elasticity β falls with the markup. Other things equal, the greater the
conversion factor φ , the more the product can be “split” or “cut” and the higher is the profit
from the operation. The role of the conversion factor in equation (2.14) is then to normalise
11
by deflating the markup by the size of the conversion involved (e.g., in going from ounces to
grams), thus making the size elasticity a pure number. To illustrate the workings of equation
(2.14), suppose that the markup is 100 percent, so that δ = 2 , and we convert from ounces to
grams, in which case = 28 φ . With these values, β = 1  log 2 log 28 0.8 ≈ , so that a
doubling of package size is associated with an 80 percent increase in price. Equation (2.14) is
an elegant result which yields some additional understanding of the interactions between price
and package size.
Pricing Strategies
A branch of the literature views the pricepackage relationship as part of producers’
competitive strategy. Here subtle forms of price discrimination are practiced by charging
different classes of consumers of a given good a different unit price. Such practises are
inconsistent with competitive markets, and there must be some form of barrier (real or
artificial) preventing arbitrage between the different classes of consumers.
Mills (2002, pp. 121127) studied about 1,750 prices for 149 products sold at Sydney
supermarkets. In a number of instances he found quantity surcharges, whereby unit prices
increase with package size, the opposite to the more familiar case of discounts for larger
quantities.
2
Overall, about 9 percent of cases represented quantity surcharges and these were
concentrated in five product groups: Toothpaste for which 33 percent of cases were
surcharges; canned meat (33 percent); flour (23 percent); snack foods (19 percent); and paper
tissues (19 percent). To account for the observed surcharge on the largest package size of
toothpaste, Mills (p. 122) argues that “… manufacturers probably believe that a significant
proportion of customers will nevertheless choose that size  on grounds of convenience, or
because the customers think (without checking) that there will be a quantity discount”. In
other words, as prices do not reflect costs, toothpaste manufacturers probably practice price
discrimination. Moreover, Mills (p. 124) argues that a quantity discount can also be consistent
with price discrimination if not all of the cost savings associated with a larger quantity are
passed onto consumers.
3
2
Quantity surcharges have also been identified in several earlier studies (Cude and Walker, 1984, Gerstner and
Hess, 1987, Walker and Cude 1984 and Widrick, 1979a, b), as discussed by Mills (2002, pp. 119120).
3
For a further analysis, see Mills (1996). We shall return to Mills’ data in Section 9 below.
12
Others argue that in some instances, unit price differences reflect equalising price
differences, rather than price discrimination. Telser (1978, p. 339), for example, discusses the
case of those who buy larger quantities less frequently and pay lower unit prices:
Assume that the retailer has two kinds of customers for some product,
customers who buy large amounts for their inventory and customers who
buy small amounts more frequently. When there is a large price decrease,
there is a large sales increase to those who are willing to store the good.
Sales to this group drop sharply after the price reduction and may
subsequently return to the normal level. The behaviour of these customers
impose a constraint on the retailer, since he cannot expect the same effect on
his rates of sale to them for given price reductions without regard to their
timing. Those who buy small amounts frequently will not buy much more at
temporarily lower prices. Such buyers will have a relatively steady demand
over time. Hence sellers hold larger stocks relative to the mean rate of sales
for the light buyers than for the heavy buyers. The difference between the
regular and the sales price represents the cost of storage to the sellers and is
therefore an equalising price difference. It is most emphatically not an
example of price discrimination. On the contrary, it is a price pattern
consistent with a competitive market.
3. MARIJUANA PRICES
In this section we present data on marijuana prices purchased in the form of two package
sizes, ounces and grams. These data were supplied by the Australian Bureau of Criminal
Intelligence and refer to the period 199099 and the eight states and territories of Australia.
For a listing of the data and further details, see the Appendix.
Figure 2 (which has the same format as Figure 1) plots the ounce price against the gram
price for two broad types of marijuana, leaf and heads. As all prices are expressed in terms of
dollars per ounce, they are directly comparable. As can be seen, all the observations lie below
the 45° line, indicating that the unit price for ounce purchases are less than those for gram
purchases. Table 1 presents the quantity discounts in logarithmic form, with the negative
signs confirming the presence of discounts. Looking at the last entry in the last column for
leaf (panel I of the table), we see that for Australia as a whole on average there is an 85
percent discount from buying ounces rather than grams; the corresponding mean for heads is
79 percent. While these are clearly substantial discounts, it should be kept in mind that to
gain such a discount a substantially larger purchase must be made (28 times larger, to be
precise).
13
FIGURE 2
OUNCE AND GRAM PRICES OF MARIJUANA
(Dollars per ounce)
A. Leaf B. Heads
100
300
500
700
900
1100
1300
1
0
0
3
0
0
5
0
0
7
0
0
9
0
0
1
1
0
0
1
3
0
0
Gram price
Ounce
price
100
300
500
700
900
1100
1300
1
0
0
3
0
0
5
0
0
7
0
0
9
0
0
1
1
0
0
1
3
0
0
Gram price
Ounce
price
In Figure 3 we plot the discounts for leaf (in panel A), heads (panel B) and leaf and
heads combined (panel C). The two products leaf and heads are combined by weighting them
according to their relative importance in consumption, guesstimated to be .3 and .7,
respectively (Clements, 2002a)
4
. The combined histogram is unimodal, (at about –70
percent), somewhat less “raggard” than the other two and the mean discount is about 80
percent. Note also that all three histograms seem to have long lefthand tails, which probably
reflects the high variability of the underlying data (Clements, 2002a).
4
In a conventional histogram, each observation is equally weighted and the vertical axis records the number of
observations falling in each bin. For the weighted version, such as panel C of Figure 3, observations in each bin
are sorted into the two products, weighted according to the above scheme and then the weighted number of
observations is recorded on the vertical axis. Accordingly, the area of a given column of the weighted histogram
is proportional to the productweighted importance of the observations that fall within the relevant bin.
45° 45°
14
TABLE 1
DISCOUNT FOR BULK BUYING OF MARIJUANA
(100 × logarithmic ratios of ounce to gram prices)
Region
Year NSW VIC QLD WA SA NT TAS ACT Australia
I. Leaf
1990 56.4 36.0 113.5 134.0 59.0 93.4 106.7 42.2 65.1
1991 79.3 53.7 118.0 151.1 56.0 93.4 109.9 68.1 80.6
1992 107.4 65.7 120.9 72.2 91.2 84.7 131.5 58.8 93.5
1993 42.0 55.3 140.3 118.3 48.5 86.1 125.4 86.7 68.4
1994 86.8 57.2 127.5 88.8 66.2 100.3 95.8 63.3 82.6
1995 122.4 56.0 33.6 82.1 59.6 91.6 123.4 107.9 82.4
1996 146.0 72.8 64.2 97.9 58.8 109.7 93.2 54.0 102.8
1997 158.1 54.2 26.2 90.9 58.8 91.4 33.6 46.3 96.8
1998 119.2 70.5 51.9 62.5 62.4 82.3 21.9 47.4 84.1
1999 143.5 70.9 45.5 79.9 58.8 84.7 89.6 44.2 93.1
Mean 106.1 59.2 84.2 97.8 61.9 91.8 93.1 61.9 84.9
II. Heads
1990 62.4 48.0 122.1 62.4 125.3 76.7 55.0 59.6 73.3
1991 62.4 71.1 119.2 65.0 194.6 76.7 91.2 80.6 84.0
1992 131.7 91.2 85.2 68.0 65.7 44.2 105.9 43.2 101.2
1993 54.6 64.8 86.0 66.7 95.8 65.7 99.1 66.8 68.7
1994 74.2 74.1 118.1 74.2 96.9 86.3 70.5 57.8 83.0
1995 79.4 68.4 96.9 74.9 95.5 79.5 119.4 85.8 81.8
1996 75.6 74.2 66.1 77.3 80.7 108.8 90.9 98.1 75.4
1997 93.4 76.3 15.8 84.7 74.2 88.0 60.3 58.5 74.0
1998 83.1 77.2 27.3 82.9 90.4 92.9 67.8 62.4 71.1
1999 87.0 45.4 67.5 80.6 74.2 103.0 66.2 74.2 73.5
Mean 80.4 69.1 80.4 73.7 99.3 82.2 82.6 68.7 78.6
15
FIGURE 3
HISTOGRAMS OF DISCOUNT FOR BULK
BUYING OF MARIJUANA
(100 × logarithmic ratios of ounce to gram prices)
A. Leaf
0
2
4
6
8
10
12
14
16
140 130 120 110 100 90 80 70 60 50 40 More
F
r
e
q
u
e
n
c
y
Mean = 82
SE of mean = 3.6
Median = 81
B. Heads
0
2
4
6
8
10
12
14
16
18
20
140 130 120 110 100 90 80 70 60 50 40 More
F
r
e
q
u
e
n
c
y
Mean = 80
SE of mean = 2.7
Median = 77
C. Leaf and Heads
0
2
4
6
8
10
12
14
16
140 130 120 110 100 90 80 70 60 50 40 More
F
r
e
q
u
e
n
c
y
Mean = 80
SE of mean = 2.2
Median = 78
16
4. THE SIZE AND DISCOUNT ELASTICITIES
It is convenient to introduce at this juncture a slightly different notation that will be used
in the remainder of the paper. Let
s
p′ be the price of marijuana sold in the form of a packet of
size s, s 1 = for a gram packet and s 28 = for an ounce packet. It is to be noted that as the
quantity units differ, the two values of
s
p′ are not directly comparable as
1
p′ is measured in
terms of dollars per gram, while
28
p′ is in dollars per ounce. Consider the following
relationship between price and packet size:
(4.1)
s
log p = α + β logs ′ ′ ,
where β′ is the size elasticity of the price. As we have previously observed substantial
quantity discounts for marijuana, the price increases less than proportionately to size, so we
expect 0 < β < 1 ′ . As
s
p / s ′ is the price per gram, this version of the price is comparable for
s 1, 28. = We shall refer to
s
p / s ′ as the unit price. To simplify the notation, write
s
p for the
unit price
s
p / s ′ , and let β = β  1 ′ , which we shall call the discount elasticity, the percentage
change in the unit price resulting from a onepercent increase in packet size. It follows from
equation (4.1) that
(4.2)
s
log p = α + βlogs ,
so that the unit price falls for largersized purchases if β < 0 , or when the size elasticity
β < 1 ′ .
Next, consider the price of ounce purchases in terms of the price of grams. There are two
versions of this relative price,
28 1 28 1
p / p and p / p ′ ′ . The units of the relative price
28 1
p / p ′ ′ are
grams per ounce, while those of
28 1
p / p are grams per gram, which is a pure number. We
previously measured the quantity discount available by buying in ounces rather than grams by
the logarithmic ratio ( )
28 1
log p / p . In logarithmic terms, it follows from equations (4.1) and
(4.2) that these relative prices can be expressed as
17
28 28
1 1
p p
log = β log 28, log = β log 28
p p
′
′
′
.
It then follows that the size and discount elasticities, β and β ′ , are related to the relative
prices according to
(4.3)
28 28
1 1
p p
log log
p p
β = , β =
log 28 log 28
′
′
′ .
In the previous section we observed that the quantity discount was of the order of 80 percent;
that is, ( )
28 1
log p / p .80 ≈ − . Using this value, together with log 28 3.33 ≈ , it follows from the
second member of equation (4.3) that an estimate of the discount elasticity is
(4.4)
28
1
p
log
p .80
ˆ
β = .25
log 28 3.33
≈ ≈ .
In Section 6 we shall show that this way of estimating β has some attractions.
Recall that the quantity discount ( )
28 1
log p / p is a pure number: Marijuana is
approximately 80 percent cheaper if purchased in the form of ounces rather than grams. But
this percentage has embodied in it the transition from grams to ounces, which involves a
factor of 28. As revealed by equation (4.3), the discount elasticity β normalises the discount
by deflating it by log 28. The upshot of this is that while the quantity discount is not
comparable across products involving size differences other than ounces/grams, the discount
elasticity β has no such problems. Note that equation (4.4) implies an estimated size elasticity
of
ˆ ˆ
β = β + 1 .75 ′ ≈ , so that the rate of increase of marijuana prices is only about three
quarters of the proportionate increase in package size.
5. SIZE AND THE DISTRIBUTION OF PRICES
Rather than just two sizes of the product, now consider a larger number given by the set
G. It is then possible to consider the nature of the distribution of prices, and its relationship to
18
package size. Let
s
w be the market share of the product when sold in the form of size s ∈G,
with
s s
w 1
∈
∑ =
G
.
We summarise the prices and sizes by their weighted geometric means, the logarithms of
which are:
(5.1)
s s s
s s
log P = w log p , logS = w logs
∈ ∈
∑ ∑
G G
.
The use of market shares as weights serves to give more weight to the more popular sizes,
which is reasonable. The mean of the prices can also be viewed as a stochastic price index
with the following interpretation (Theil, 1967, p. 136). Consider the prices
s
log p , s ∈G, as
random variables drawn from a distribution of prices. Suppose we draw prices at random
from this distribution such that each dollar of expenditure has an equal chance of being
selected. Then, the market share
s
w is the probability of drawing
s
log p , so that the expected
value of the price is
s s s
w log p
∈
∑
G
, which is the first member of equation (5.1). A similar
interpretation applies to the mean packet size logS. It follows directly from equation (4.2)
that the two means are related according to
(5.2) log P = α + βlogS.
This shows that the mean price is independent of mean size under the condition that there is
no quantity discount, as then the size elasticity of prices, β′ , is unity and β = 0 . When there
are quantity discounts, β < 0 and the mean price falls as the mean size rises.
The means in (5.1) can be considered as weighted firstorder moments of the price and
size distributions. The corresponding secondorder moments are
(5.3) ( ) ( )
2 2
p s s s s
s s
w log p log P , w logs logS
∈ ∈
Π = Σ − Π = Σ −
G G
.
These measures are nonnegative, increase with the dispersion of the relevant distribution and
can be referred to as the price and size variances. It follows from equations (4.2) and (5.2)
19
that the deviation of the price of the product of size s from its mean,
s
log p log P − , is
related to the corresponding size deviation, logs logS − , viz.,
( )
s
log p  log P = β logs  logS . Squaring both sides of this equation, multiplying by the
relevant market share
s
w and then summing over s ∈G, we obtain the result
2
p s
= β Π Π , or
(5.4)
p s
= β ∏ ∏ .
In words, the standard deviation of prices is proportional to the standard deviation of sizes,
with β the factor of proportionality. As β is expected to be a fraction, result (5.4) implies
that the dispersion of prices is less than that of sizes. Only when the size elasticity is unity,
β = 0 and the price distribution is degenerate; this, of course, follows from equation (4.2)
with β = 0 , as then each price takes the same value α . Note also that result (5.4) has an
interesting symmetry property for quantity discounts and premia. If we have two values of the
size elasticity β = 1 k ′ ± , for k > 0 , then the values of the discount elasticity are β = k ± .
In the case when β = 1 + k ′ , the price increases more than proportionately to size, there is a
size premium and the “discount” elasticity is positive, β = k . As equation (5.4) involves the
absolute value of β , for a given standard deviation of sizes, the dispersion of prices when
β = k is identical to that when β = k − .
To illustrate the workings of the above concepts, we use the marijuana data with two
package sizes, ounces and grams. Guesstimates of the two market shares are 20 percent for
grams and 80 percent for ounces (Clements, 2002a), so that
1
w .2 = and
28
w .8 = . Using
the price data given in the Appendix, we compute the index defined in the first member of
equation (5.1) and the results are given in Table 2 for leaf and heads. These indexes are
expressed as ( ) exp log P , so the units are dollars per ounce. The second last entries in the
last column of each of the two panels of Table 2 show that for Australia as a whole in 1999,
the index of leaf prices is $388 per ounce, while that of heads is $468. Regarding the package
size index, this is a constant equal to
1 28
log S w log 1 w log 28 .8 3.33 2.67 = + = × = , or, in
terms of grams, ( ) S exp logS 14.4 = = . Using exactly the same approach, we compute the
variance of prices defined in equation (5.3) and the results are given in Table 3 in the form of
20
standard deviations; it can be seen from equation (5.3) that this measure of dispersion is unit
free. About 74 percent of the standard deviations of the leaf prices fall in the range 2040
percent; while for heads, about 88 percent fall in this range. As before with the first moment,
the variance of size is a constant, and equal to
s
1.33 Π = . It follows from equation (5.4)
that the ratio of
p
Π to
s
Π equals β , the absolute value of the discount elasticity.
Figure 4 gives histograms of these ratios for the two products in all years and all regions
(panels A and B), as well as for the two products combined (panel C).
5
As can be seen, the
means (and medians) are of the order of .25, which agrees with the previous estimate of the
discount elasticity given in equation (4.4).
6. ECONOMETRIC ISSUES
Equation (4.2) is a relationship between the unit price of package size
s
s, p , and its size.
We apply this equation at time ( ) t t 1, , T = … and add a disturbance term
st
: ε
(6.1)
s t st
log p = α + βlogs + ε ,
where α is the intercept and β the discount elasticity. Before implementing this equation,
it is useful to explore the nature of the leastsquares estimates.
Suppose we have price data on two package sizes, ounce and grams. If we measure
size in terms of grams, we can then write
28
p for the per gram price of an ounce purchase and
p
1
for the gram price of a gram purchase. Let  
st st s1 sT
y = log p , y ,…, y
′
be a vector of T
observations on the price of package size s , s = 1, 28 ; ι be a column vector of T unit
5
As for Figure 3, the ratios for the two products are combined by weighting them according to their relative
share in consumption of .3 for leaf and .7 for heads.
21
TABLE 2
INDEXES OF MARIJUANA PRICES
(Dollars per ounce)
Region
Year NSW VIC QLD WA SA NT TAS ACT Australia
I. Leaf
1990 490 551 282 275 437 332 387 449 444
1991 557 501 272 230 447 332 436 372 448
1992 449 414 239 393 270 355 245 394 377
1993 417 457 222 253 427 334 225 297 374
1994 498 442 234 344 371 298 206 454 402
1995 407 447 428 363 391 353 209 318 413
1996 435 443 398 344 394 328 241 455 418
1997 395 318 454 315 394 346 401 423 388
1998 423 418 416 283 396 354 392 495 407
1999 366 361 486 293 394 355 313 492 388
Mean 444 435 343 309 392 339 305 415 406
II. Heads
1990 680 715 527 680 514 379 586 522 646
1991 680 634 539 572 295 379 540 441 596
1992 488 540 460 447 414 492 525 545 491
1993 558 396 431 493 545 414 419 438 481
1994 638 426 415 464 516 386 418 617 511
1995 631 459 388 411 530 420 444 520 506
1996 640 464 454 379 477 352 465 639 517
1997 663 466 555 355 464 427 432 497 540
1998 576 453 581 325 407 391 420 510 504
1999 610 438 343 294 464 369 371 556 468
Mean 616 499 470 442 463 401 462 528 526
elements; 0 be a vector of zeros; and  
1
=
′
′ ′
28
ε ε ε , with  
s s1 sT
= ,...,
′
ε ε ε . Then as
log 1 0, = we can write equation (6.1) for s 1, 28 and t 1, , T = = … in vector form as
1
28
,
log 28
1
28
α
= +
β
y 0
y
ι ε
ι ι ε
22
TABLE 3
STANDARD DEVIATIONS OF MARIJUANA PRICES
(
p
100 Π × )
Region
Year NSW VIC QLD WA SA NT TAS ACT Australia
I. Leaf
1990 22.6 14.4 45.4 53.6 23.6 37.4 42.7 16.9 26.1
1991 31.7 21.5 47.2 60.4 22.4 37.4 43.9 27.2 32.2
1992 43.0 26.3 48.4 28.9 36.5 33.9 52.6 23.5 37.4
1993 16.8 22.1 56.1 47.3 19.4 34.5 50.1 34.7 27.3
1994 34.7 22.9 51.0 35.5 26.5 40.1 38.3 25.3 33.1
1995 49.0 22.4 13.5 32.8 23.9 36.7 49.4 43.2 32.9
1996 58.4 29.1 25.7 39.1 23.5 43.9 37.3 21.6 41.1
1997 63.3 21.7 10.5 36.4 23.5 36.5 13.5 18.5 38.7
1998 47.7 28.2 20.8 25.0 24.9 32.9 8.8 19.0 33.7
1999 57.4 28.4 18.2 32.0 23.5 33.9 35.8 17.7 37.2
Mean 42.5 23.7 33.7 39.1 24.8 36.7 37.2 24.8 34.0
II. Heads
1990 25.0 19.2 48.8 25.0 50.1 30.7 22.0 23.8 29.3
1991 25.0 28.4 47.7 26.0 77.8 30.7 36.5 32.3 33.6
1992 52.7 36.5 34.1 27.2 26.3 17.7 42.3 17.3 40.5
1993 21.8 25.9 34.4 26.7 38.3 26.3 39.7 26.7 27.5
1994 29.7 29.6 47.2 29.7 38.8 34.5 28.2 23.1 33.2
1995 31.8 27.4 38.7 30.0 38.2 31.8 47.8 34.3 32.7
1996 30.2 29.7 26.4 30.9 32.3 43.5 36.4 39.2 30.2
1997 37.4 30.5 6.3 33.9 29.7 35.2 24.1 23.4 29.6
1998 33.2 30.9 10.9 33.2 36.2 37.2 27.1 25.0 28.4
1999 34.8 18.2 27.0 32.3 29.7 41.2 26.5 29.7 29.4
Mean 32.2 27.6 32.2 29.5 39.7 32.9 33.1 27.5 31.4
or using an obvious notation, = + y Xγ ε . It follows that
(6.2) ( )
1
2 log 28 1
1
1
log 28
= Tlog 28 ,
2
Tlog 28 1
1 log 28 log 28
−
−
′ ′ =
−
X X X X ,
st
s t 1
28 28, t
t
Σ Σ y
= =
0 log 28 log 28 Σ y
′ ′
′
′
y ι ι
X y
y ι
.
23
FIGURE 4
HISTOGRAMS OF RATIOS OF STANDARD DEVIATION OF PRICES
TO STANDARD DEVIATION OF SIZE
A. Leaf
0
5
10
15
20
25
Less 0.15 0.20 0.25 0.30 0.35 0.40 More
F
r
e
q
u
e
n
c
y
Mean = .25
SE of mean = .10
Median = .24
B. Heads
0
5
10
15
20
25
30
Less 0.15 0.20 0.25 0.30 0.35 0.40 More
F
r
e
q
u
e
n
c
y
Mean = .24
Se of mean = .09
Median = .23
C. Leaf and Heads
0
5
10
15
20
25
Less 0.15 0.20 0.25 0.30 0.35 0.40 More
F
r
e
q
u
e
n
c
y
Mean = .24
SE of mean = .09
Median = .23
24
The LS estimator of the coefficient vector γ is ( )
1 −
′ XX Xy . In view of the special
structure of model (6.1) and using the above results, the estimator takes the form
( )
( )
st 28, t
s t t
st
s t
28, t
st 28, t
t
s t t
1
1 28 28
ΣΣ y  Σ y
log 28 1
ΣΣ y
1 1
=
2
1
Tlog 28 T 1 log 28 Σ y
 ΣΣ y + 2Σ y
log 28
log 28
y
= y  y + 2 y ,
1
log 28
where ( )
s t st
y 1/ T y = Σ is the logarithmic mean price of package size s. As   ,
′
= α β γ in
terms of the parameters of equation (6.1), we have
(6.3)
28 1
1
y y
ˆ
ˆ y ,
log 28
−
α = β = .
In words, the estimated intercept is the mean of gram prices, while the slope is the excess of
the ounce price mean over the gram price mean, normalised by the difference in package size,
log 28 log1 log 28 − = .
6
It is to be noted that the above expression for the estimate of the
discount elasticity is exactly the same as that of equation (4.4). The covariance matrix of the
LS estimator is ( )
1
2
ˆ ,
−
′ σ XX where
2
ˆ σ is an estimate of the variance of
st
, ε the disturbance in
equation (6.1). It follows from the diagonal elements of the matrix on the far right of equation
(6.2) that
( )
( )
( )
2 2
2
ˆ ˆ 2
ˆ
ˆ var , var
T
T log 28
σ σ
α = β = .
The dependent variable in equation (6.1) is the unit price. Why use this, rather than the
total price of package
s s
p s p , ′ = × and then estimate the size elasticity ( ) 1 , ′ β = +β according
to equation (4.1)? Although either way would yield the same estimates of and , ′ β β it may
appear preferable to use the unit price as the dependent variable because of units of
6
Another way to establish result (6.3) is to note that as equation (6.1) will pass through the means for both grams
and ounces, we have for the two package sizes
1
ˆ y =α ,
28
ˆ
ˆ y log 28 =α+ β . These two equations then yield
result (6.3).
25
measurement considerations. The units of
s
p are comparable across different package sizes
as they are expressed in terms of dollars per gram. By contrast, the units of
s
p′ differ from
dollars per gram, for s = 1, to dollars per ounce, for s = 28 . One could then argue that as
the variance of
28
p′ would be likely to be greater than ( )
1
var p′ , the disturbances could be
heteroscedastic. But such an argument does not apply when we use the logarithms of the
prices as then the factor converting one price to another becomes an additive constant rather
than multiplicative, so that ( ) ( )
s s
var log p = var log p′ .
The price data underlying the LS estimates given in equation (6.3) are expressed in terms
of dollars per gram. It would be equally acceptable, however, to use dollars per ounce as the
alternative unit of measurement. How do the estimates (6.3) change if we use prices per
ounce, rather than prices per gram? Intuition suggests that the estimated intercept would
become the mean of prices of ouncesized packets; and that the estimated slope would remain
unchanged as this is an elasticity, which is a dimensionless concept. We now briefly
investigate this issue. Recall that
s
p is the price per gram when marijuana is purchased in a
package of size s , s = 1 (grams), 28 (ounces) . These prices can be expressed in terms of
ounces simply by multiplying by 28. Thus using a “ ˜ ” to denote prices and sizes expressed
in terms of ounces, we have
s 28 s
p = 28 × p , or
s s
p = 28 × p
, with ( ) s = 1 28 × s for
s = 1 28 (grams), 1 (ounces) . To enhance understanding of the workings of this notational
scheme, it can be enumeratored as follows:
Unit of Measurement
Grams Ounces
Size Price Size Price
Package size
s
s
p
s
s
p
Gram 1
1
p 1 28
1 28
p
Ounce 28
28
p 1
1
p
When using ounces, equation (6.1) becomes
(6.1′)
s t s t
log p = α + βlogs + , s = 1 28, 1; t = 1,...,T ε
.
26
As logs = log28 for s = 1 28 and logs = 0 for s 1 = , proceeding as before, we have
1 28
1
log 28
1 28
1
−
= +
y α
y 0 β
ι ι ε
ι ε
or = + ε y Xγ
. Thus
7
( )
1
2 log 28 1
1
1
log 28
T log 28 ,
2
T log 28 1
1 log 28 log 28
−
−
′ ′ = =
−
XX XX
s t
s t 1 28
1 1 28, t
t
y
log 28 log 28 y
∑∑
′ ′
′ = =
′ − − ∑
y
Xy
y 0
ι ι
ι
.
The LS estimates now thus take the form
( )
( )
st 1 28,t
s t t st
s t
1 28,t
st 1 28,t
t
s t t
1 28 1 1 28
1 28 1 1 28
y y
log28 1
y
1 1
2
1
T log28 T 1 log28 y
y 2 y
log28
log28
y y y
.
1
y y 2y
log28
∑∑ − ∑
∑∑
=
− ∑
∑∑ − ∑
+ −
=
+ −
Thus the estimates of the parameters of equation (6.1′) are
(6.3′)
1 1 28
1
y y
ˆ
ˆ
y ,
log 28
−
α = β =
.
7
Note that the relationship between the ounce and gram notation is as follows: log 28 = + y y ι and
  log 28 = + −
X X 0 ι , where ι is a vector of 2T unit elements and 0 is a vector of 2T zero elements.
27
As
s s
p 28 p = ×
, with s s 28 = ,
s 28s
p 28 p = ×
. In logarithmic terms, the two sets of
prices are thus related according to
s 28s
y log28 y = +
, so that
1 28
y log 28 y = + and
1 28 1
y log 28 y = + . It thus follows from equations (6.3) and (6.3′) that
28 28 1
ˆ
ˆ ˆ
log 28 y , ( y y ) log 28 α = + β = − = β
. This establishes that in moving from grams
to ounces as the unit of measurement (i) the estimated intercept becomes the logarithmic
mean of the prices of the ouncesized packages; and (ii) the estimated size elasticity remains
unchanged. The respective standard errors of
ˆ
α and
ˆ
β
are identical to those of ˆ α and
ˆ
β .
7. HEDONIC REGRESSIONS
The hedonic regression model relates the overall price of a product to its basic
characteristics, and “unbungles” a package of attributes by estimating the marginal
cost/valuation of each characteristic in the form of a regression coefficient. The seminal
paper on this topic is Rosen (1974). Equation (6.1) can be thought of as a hedonic regression
equation in which marijuana has one characteristic, package size. A recent paper by Diewert
(2003) considered some unresolved issues in hedonic regressions that are relevant to the
previous discussion, and the following is a simplified summary of some of his results.
Consider a crosssection application in which p
1
,…, p
K
are the prices of K types of a
certain product, such as a personal computer, and z
1
,…, z
K
are the corresponding values of a
single characteristic of each type, such as the amount of memory of each of the K computers.
Consider further the hedonic regression:
(7.1) ( ) ( )
k k k
f p g z , k 1,..., K = α + β + ε = ,
where ( )
k
f p is either the identity or logarithmic function, so that ( )
k k
f p p = or
( )
k k
f p log p = ; ( )
k
g z is also either the identity of logarithmic function; α and β are
coefficients to be estimated; and
k
ε is a disturbance term with a zero mean and a constant
variance. The question to be discussed is, what form should the functions ( ) f and ( ) g
take, the identity or logarithmic? Suppose we use the logarithm of the price on the left of
28
model (7.1) and the identity function for the characteristic. One advantage of doing this is
that the coefficient β is then interpreted as the (approximate) percentage change in the price
resulting from a oneunit increase in the characteristic. When we additionally use
k
log z on
the right, then β becomes the elasticity of the price with respect to z . Assume we have
k
log p on the left of (7.1), and we wish to test the benchmark hypothesis that the price
increases proportionately with the characteristic z ; in other words, that there are constant
returns to scale so that the price per unit of the characteristic (
k k
p z , the price of a computer
per unit of memory) is constant. With
k
log p on the left of (7.1), this test can be
implemented by setting ( )
k k
g z log z = and testing 1 β = . This convenient property points
to the use of logarithms on both sides of model (7.1).
Now consider the stochastic properties of the disturbance
k
ε in equation (7.1). When
( )
k k
f p p = and ( )
k k
f p log p = , we have, respectively,
(7.2a) (0.1) ( )
k k k
p g z ε = − α − β
(7.2b)
( ) { }
k
k
k
p
exp g z
′ ε =
α + β
,
where ( )
k k
exp ′ ε = ε . Which disturbance is more likely to have a constant variance? As
products with a high value of
k
z are likely to be more expensive, and vice versa, the
disturbances in equation (7.2a) would be likely to take higher values for more expensive
products, and lower for cheaper ones. Consequently, these disturbances are likely to be
heteroscedastic. This would possibly be less of a problem with the logarithmic formulation
(or its transform, the exponential) in equation (7.2b) as this involves the ratio of the price to
its mean, which is more likely to have a constant variance. That is, while more expensive
products would still tend to have larger disturbances, if these errors are more or less
proportional to the corresponding prices, then the variance of the ratio of the price to the
conditional mean will be more or less constant. This argument also favours the use of the
logarithm of the price on the left of equation (7.1).
Next, consider the implications of ensuring that the hedonic regression model is invariant
to a change in the units of measurement of the characteristic z . Suppose that the function
( ) f is unspecified, ( ) g is logarithmic, and that the characteristic is now measured as
29
z z c
∗
= with c a positive constant. The hedonic model now takes the form
( )
k k
f p log z
∗ ∗ ∗
= α + β , where
∗
α and
∗
β are new coefficients. Invariance requires that
the prices predicted by the two models coincide, so that
k k
log z log z
∗ ∗ ∗
α + β = α + β for all
values of z . This implies that the two sets of coefficients are related according to
∗
β = β
and logc
∗ ∗
α = α − β . Note in particular that invariance requires that there be an intercept in
the model.
Some types of the product will typically be more economically important than others,
which raises the question of weighting. If there are only three types of the product and the
sales of the first are twice those of the second and third, for example, it would then seem
natural for the first product, relative to the second and third, to receive twice the weight in the
hedonic regression. While these issues usually involve questions about how to induce
homoscedasticity in the disturbance term, Diewert (2003) emphasises the idea from index
number theory that the regression should be representative. To justify this approach, Diewert
quotes Fisher (1922, p. 43):
It has already been observed that the purpose of any index number is to strike a
‘fair average’ of the price movements  or movements of other groups of
magnitudes. At first a simple average seemed fair, just because it treated all
terms alike. And, in the absence of any knowledge of the relative importance of
the various commodities included in the average, the simple average is fair. But
it was early recognized that there are enormous differences in importance.
Everyone knows that pork is more important than coffee and wheat than quinine.
Thus the quest for fairness led to the introduction of weighting.
Paraphrasing Diewert (2003, p. 5) slightly to accommodate our terminology and notation, he
justifies weighting as follows:
If product type k sold
k
q units, then perhaps product type k should be
repeated in the hedonic regression
k
q times so that the regression is
representative of sales that actually occurred.
Diewert argues that an equivalent way of repeating the observation on product type k
k
q
times is to weight the single observation by
k
q . The sense in which these two approaches
are equivalent is that the LS estimators of the model with repeated observations are identical
to those of the weighted model; Diewert refers to Greene (1993, pp. 27779) for a proof. The
weighted approach has the advantage that we are able to assume more plausibly that the
30
disturbances are iid. As the disturbances of the repeatedobservation approach are identical
for a given type of product, they obviously cannot be independently distributed. Although the
(square roots of) quantity weights are preferable to equal weights, value weights are even
better. The reason is that quantity weights tend to under (over) represent expensive (cheap)
products; the value, price × quantity, strikes a proper balance between the two dimensions of
the product. Accordingly, Diewert favours weighting observations in model (7.1) by the
square roots of the corresponding value of sales. This is, of course, equivalent to weighting
by the square roots of the market shares as these differ from sales by a factor proportionality,
the reciprocal of the square root of total sales, which drops out in the LS regression. The
occurrence of the square roots of shares in regressions involving prices is familiar from the
stochastic index number theory of Clements and Izan (1981, 1987) and and Selvanathan and
Rao (1994).
To summarise, Diewert (2003) has a preference for logarithms to be used on both sides
of the hedonic model (7.1), for an intercept to be included and for that model to be estimated
by weighted LS, with weights equal to the square roots of the value of sales or, equivalently,
market shares. Equation (6.1) satisfies the first two of these three desiderata. We now
analyse the impact of weighting on this equation. Let
st
w be the market share of marijuana
sold in package size s ( s 1, 28 = for grams and ounces) in year t , with
1, t 28, t
w w 1 + = .
We multiply both sides of equation (6.1) by the square root of this share to give
(7.3)
st st st st st st
w y w w logs w = α + β + ε ,
where
st st
y log p = . We write this equation for s 1, 28 = and t 1,..., T = in vector form as
1 1 1 1 1
28 28 28 28 28 28
log 28
α
= +
β
W y w 0 W
W y w w W
ε
ε
,
where
s s
diag
=
W w ;
s s1 sT
w ,..., w
′
=
w ;  
s s1 sT
y ,..., y
′
= y ; 0 is a vector of
zeros; and  
s s1 sT
,...,
′
= ε ε ε . If we let
T
s t 1 st
w w
• =
= ∑ , it then follows from the constraint
1t 28, t
w w 1 + = that
1 28
w T w
• •
= − . Writing the above as = + y Xγ ε , we have
31
( )
( )
1
28
28
28
28
t 1t 1t t 28, t 28, t
1 28 1 1
t 28, t 28, t
28 28 28
T log 28 1
1
1
w log 28
w log 28 , ,
T
T w log 28
1
w log 28 1 log 28
w y w y
.
log 28 w y
log 28
−
•
•
•
•
−
′ ′ = =
−
−
∑ + ∑ ′ ′
′ = =
∑ ′ ′
X X X X
w w W y
X y
0 w W y
The LS estimator for the coefficient vector of γ , ( )
1 −
′ ′ X X X y , thus takes the form
( )
t 1t 1t t 28, t 28, t
28
t 28, t 28, t
28
t 1t 1t t 28, t 28, t t 28, t 28, t
28
t 1t 1t t 28, t 28, t t 28, t 28, t
28
log 28 1
w y w y
1
T
T w log 28
1 log 28 w y
w log 28
w y w y w y
1
1 T
T w
w y w y w y
log 28 w
•
•
•
•
−
∑ + ∑
−
− ∑
∑ + ∑ − ∑
=
 
−
−∑ − ∑ + ∑

\ .
1t
t 1t
28
t 28, t 28, t t 1t 1t
28 28
w
y
T w
1 1 T
1 w y w y
log 28 T w w
•
• •
∑
−
=
¦ ¹  
¦ ¦
− ∑ − ∑
´ ` 
−
¦ ¦ \ . ¹ )
1t
t 1t
28
28, t
1t
t 28, t t 1t
28 28
w
y
T w
.
w
w 1
y y
log 28 w T w
•
• •
∑
−
=
 
∑ − ∑

−
\ .
As
t 1t 28
w T w
•
∑ = − and
t 28, t 28
w w
•
∑ = , the terms ( )
1t 28
w T w
•
− and
28, t 28
w w
•
are both normalised shares, each with a unit sum. We write these as
st st s
w w w
•
′ = . Thus
the estimates of the parameters of (7.3) are
(7.4)
28 1
1
y y
ˆ
ˆ y , ,
log 28
−
α = β =
where
T
s t 1 st st
y w y
=
′ = ∑ is the weighted mean of the (logarithmic) price of package size s .
In words, the estimated intercept is the weighted mean of the gram prices, while the slope
32
coefficient is the difference between the weighted means of the two prices, normalised by the
difference in the package size, log 28 log1 log 28 − = . Result (7.4) is to be compared with
(6.3). As can be seen, both have exactly the same form, and the only difference is that the
former involves weighted means of the price, while the means in the latter are unweighted. It
should be noted that the weights in result (7.4) are with respect to time, not commodities.
Accordingly, if the weights are constant over time,
st s s
w 1 T, t, y y ′ = ∀ = and (7.4) then
coincides with (6.3).
8. FURTHER ESTIMATES OF THE DISCOUNT ELASTICITY FOR MARIJUANA
We return to equation (6.1) which relates the unit price of package size s at time t,
st
p ,
to the package size,
(8.1)
st st
log p logs = α + β + ε ,
where α is the intercept and β the discount elasticity; and
st
ε is a disturbance term.
Previously, we presented two types of estimates of the discount elasticity for marijuana, (i)
the preliminary estimate given in equation (4.4), which is based on the centre of gravity of the
discount available when purchasing in ounces rather than grams; and (ii) the estimates based
on the ratios of standard deviations of prices to those of the package size, given in Figure 4.
In both cases, the estimates of β are of the order of .25. In this section, we provide a third
set of estimates on the elasticity by estimating equation (8.1) with timeseries data.
Before proceeding, several items need to be discussed. First, as our market shares for
marijuana are constant over time, in view of the analysis in the previous section, there is no
gain to be had by using these shares as weights when estimating equation (8.1). Second, an
adjustment needs to be made for overall inflation during the sample period. The usual
approach to this problem in the hedonic framework is to use a dummy variable for each
period, which is known as the “adjacent year regression” (Girliches, 1971). We shall follow
this approach. Third, as our database has a regional dimension to it, in addition to the
package size and time dimensions, it would seem sensible to also control for this aspect. If
33
we denote region r by the corresponding superscript, the pricing equation to be estimated is
then
(8.2)
r r r
s t t s t
log p logs regional and time dummies = α + β + + ε .
8
To estimate equation (8.2), we use the data described in the Appendix for r 1,..., 8 =
regions, s 1, 28 = package sizes and t 1990,...,1999 = . For each of the two product, leaf
and heads, there are thus 8 2 10 160 × × = observations. Column 2 of Table 4 gives the
leastsquares estimates of equation (8.2) for leaf and as can be seen, the estimated discount
elasticity is .25 with a standard error of .01. The coefficients of the regional dummies are all
negative, indicating that leaf is cheaper in all these regions as compared to NSW. All except
one of the coefficients of the time dummies are negative, implying that leaf prices have
declined over time. These regional and temporal aspects of marijuana prices in Australia have
been previously identified (Clements, 2002b). Looking at column 3 of Table 4, we see that
the results are similar for heads, although their prices fall faster than those of leaf. The data
for leaf and heads are combined in column 4 by adding a product dummy variable. Here, the
discount elasticity is again of the same order of magnitude (.24), and the product dummy
indicates that on average leaf is about 26 percent cheaper than heads. This difference in
prices agrees with the information presented in Table 2, from which it can be seen that on
average over the ten years the price of heads at the national level is $526 per ounce, while that
of leaf is $406, a 23 percent difference.
In the Appendix we provide estimates of the discount elasticity β for each of the ten
years individually, for each of the two products and for the two products combined. This
amounts to ( ) 10 2 1 30 × + = estimates of β , twenty of which are independent.
Additionally, we present twentyfour reginal estimates of β , sixteen of wihich are
8
We also experimented with the following more parsimonious way of dealing with inflation and regional effects
simultaneously. Define an index of marijuana prices for region r and year t as
r r
t s 1, 28 s s t
log P w log p
=
= ∑
where
1
w .2 = and
28
w .8 = are the guesstimated market shares for grams and ounces (Clements, 2002a);
and
r
s t
p is the price of package size s in year t and region r . The relative price of marijuana is then
( )
r r
s t t
log p P , which can be used as the new dependent variable in the regression
( )
r r r r
s t t s t
log p P logs = α + β + ε . The interpretation of the coefficient α is as the expected value of
( )
r r
s t t
log p P for grams ( s 1 = ), and the coefficient β continues to be interpreted as the discount elasticity.
This approach yields point estimates of β identical to those reported in this section.
34
TABLE 4
MARIJUANA PRICING EQUATIONS
r r
st t
log p logs regional and time dummies = α + β +
(Standard errors in parentheses)
Independent variable Leaf Heads Leaf and heads
(1) (2) (3) (4)
Constant α 6.881 (.073) 7.221 (.062) 7.182 (.050)
Log s, β
.246 (.010) .239 (.009) .242 (.007)
Regional dummies
VIC .164 (.069) .257 (.059) .210 (.046)
QLD .357 (.069) .280 (.059) .319 (.046)
WA .391 (.069) .378 (.059) .385 (.046)
SA .258 (.069) .239 (.059) .248 (.046)
NT .308 (.069) .424 (.059) .366 (.046)
TAS .446 (.069) .285 (.059) .366 (.046)
ACT .206 (.069) .191 (.059) .199 (.046)
Time dummies
1991 .005 (.077) .078 (.066) .037 (.051)
1992 .114 (.077) .140 (.066) .127 (.051)
1993 .182 (.077) .214 (.066) .198 (.051)
1994 .116 (.077) .153 (.066) .135 (.051)
1995 .076 (.077) .151 (.066) .113 (.051)
1996 .023 (.077) .153 (.066) .088 (.051)
1997 .061 (.077) .196 (.066) .128 (.051)
1998 .038 (.077) .238 (.066) .138 (.051)
1999 .042 (.077) .304 (.066) .173 (.051)
Leaf dummy .263 (.023)
R
2
.818 .854 .833
SEE .272 .186 .205
No. of obs. 160 160 320
Notes: NSW is the base for the regional dummy variables, while 1990 is the base for the time dummies. In column 4, the leaf
dummy variable takes the value one for leaf and zero otherwise, so the estimate of its coefficient measures the average
proportionate difference between leaf and heads prices.
35
independent. Figure 5 presents histograms of these additional estimates; panel A deals with
the entire set of 30 24 54 + = estimates, while panel B deals with the 20 16 36 + =
independent estimates. While there is some dispersion, these histograms support the notion
that the discount elasticity is of the order of .25.
FIGURE 5
HISTOGRAMS OF DISCOUNT ELASTICITIES FOR MARIJUANA
A. Entire Set
0
2
4
6
8
10
12
14
16
18
20
.30 .28 .26 .24 .21 .19 .17
Mean=.242
SE of mean=.004
B. Independent Subset
0
2
4
6
8
10
12
.30 .28 .26 .23 .21 .19 .17
Range
Frequency
Mean = .242
SE of mean = .006
In Section 2, equation (2.14) relates the size elasticity to the markup factor ( δ ) and the
conversion factor in going from a larger package size to a smaller one ( φ ). In terms of the
present notation, this equation implies that the discount elasticity is related to these two
factors according to  log log β = δ φ . Thus, a value of .25 β = − and 28 φ = , implies a
Frequency
36
markup factor of ( ) exp .25 log 28 2.30 δ = × = , or about 130 percent in transforming ounces
into grams. This value seems not unreasonable.
9. EVIDENCE FROM OTHER MARKETS
Our investigations in the previous sections revealed that marijuana prices are subject to
substantial quantity discounts. Using several approaches, we found that marijuana prices tend
to obey the rule that the elasticity of the unit price with respect to package size is about .25.
Does this same rule apply to other markets? In this section, we examine this issue with the
prices of groceries and other illicit drugs.
Mills (2002, Chap. 7) conducted a special survey of Sydney supermarkets in January
1995 to study quantity discounts. He collected prices of prepacked goods sold in two or
more package sizes, from one store of each of the five major chains and one major franchise
group; where available, “discounted” or “special” prices are used. For a total of 149 products,
there were 423 distinct package sizes. The 149 products were then aggregated into 29 product
groups. Mills generously provided us with the basic price data for the seven product groups
listed in column 1 of Table 5. These product groups were chosen on the basis that they (i)
exclude those products for which Mills found quantity surcharges; (ii) are mostly
undifferentiated products; and (iii) are relatively homogenous.
9
We use the groceries data to regress the unit price on package size and a set of product
dummy variables to control for any withingroup heterogeneity. The results are contained in
panel I of Table 5 and as can be seen, the estimated discount elasticity ranges from .12 for
rice, to .42 for baked beans, and all are significantly different from zero. In panel II of this
table the product dummies are suppressed and the only discount elasticity that changes
appreciably is that for sugar (from .15 to .30).
Brown and Silverman (1974) analyse the pricing of heroin in a number of US cities and
relate the price per unit to package size, purity and the month of purchase. In discussing the
9
There are two exceptions to this rule: (i) “Baked beans” refer to both baked beans in tomato sauce and spaghetti
in tomato sauce. (ii) “Canned vegetables” refer to cans of green beans, mushrooms, kidney and other beans,
beetroot, peas and creamed corn.
37
TABLE 5
GROCERIES PRICING EQUATIONS
si i
log p logs product dummies = α + β +
(Standard errors in parentheses
)
Product
group
Constant Discount
elasticity
Coefficient of Product Dummies R
2
SEE
α β 2 3 4 5 6 7 8 9
No. of
obs.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
I. With Product Dummies
1. Baked beans 1.108 (.118) .419 (.020) .011 (.030) .118 (.030) .309 (.039) .885 .096 69
2. Cheese .933 (.098) .183 (.016) .026 (.033) .240 (.057) .018 (.033) .047 (.034) .144 (.034) .066 (.040) .717 .069 78
3. Flour 4.854 (.080) .259 (.052) .157 (.098) .336 (.156) .358 (.124) .298 (.124) .376 (.156) .313 (.156) .279 (.156) .262 (.156) .740 .192 35
4. Milk 4.716 (.018) .151 (.024) .156 (.038) .113 (.038) .357 (.050) .004 (.032) .114 (.050) .820 .066 32
5. Rice 4.964 (.018) .122 (.012) .057 (.036) .114 (.025) .095 (.035) .318 (.036) .095 (.027) .795 .075 71
6. Sugar 4.907 (.023) .148 (.033) .305 (.035) .154 (.035) .213 (.046) .874 .073 34
7. Canned vegetables .405 (.114) .308 (.019) .441 (.044) .246 (.045) .047 (.044) .071 (.047) .372 (.045) .383 (.046) .228 (.046) .909 .111 122
Continued on next page
38
TABLE 5 (continued)
GROCERIES PRICING EQUATIONS
si i
log p logs product dummies = α + β +
(Standard errors in parentheses)
Product
group
Constant Discount
elasticity
Coefficient of Product Dummies R
2
SEE
α β 2 3 4 5 6 7 8 9
No. of
obs.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
II. Without Product Dummies
1. Baked beans
.831 (.155) .383 (.027)
.748 .138 69
2. Cheese
.832 (.121) .176 (.020)
.511 .088 78
3. Flour
4.760 (.058) .232 (.079)
.206 .291 35
4. Milk
4.780 (.021) .149 (.040)
.318 .116 32
5. Rice
4.884 (.015) .140 (.018)
.466 .116 71
6. Sugar
4.768 (.024) .296 (.048)
.540 .132 34
7. Canned vegetables
1.030 (.219) .388 (.037)
.481 .257 122
39
possible reasons for a negative relationship between the unit price and package size, Brown
and Silverman (1974, p. 597) argue as follows:
Because of both the changing nature of the risk involved and the value added
to the product by the activities of middlemen, there is reason to believe that the
price at which a gram of heroin can be bought is affected by the quantity…of
the purchase made. A supplier may be willing to the charge less per gram
when selling a larger quantity of heroin, since the number of transactions –
and, presumably, the risk – are lower.
Later in the paper, Brown and Silverman (1974, p. 599) qualify the argument by adding in
parentheses: “Risk is not the only factor here; quantity discounts exist for licit goods as well.”
This is an important qualification since not only are licit goods subject to quantity discounts,
but as we have seen above the extent of these discounts, as measured by the discount
elasticity β , seems to be more or less the same in both licit and illicit markets, at least to a
first approximation. The results of Brown and Silverman for the discount elasticity are
summarised in Table 6. As can be seen, the mean (weighted and unweighted, given in rows
42 and 43) of these elasticities is not too different to the previous values that we estimated for
marijuana.
Caulkins and Padman (1993) extended the approach of Brown and Silverman and
applied it to the pricing of several illicit drugs. Although they estimate the size elasticities
′ β , these can be readily transformed into discount elasticiites via the relationship 1 ′ β = β − ,
which are presented in Table 7. The mean of the four elasticities for marijuana is .23, which
is consistent with our results, while that of the other six drugs is .17, which is a bit lower than
most of the prior estimates. Caulkins and Padman also provide some evidence that (the
absolute value of) β tends to fall modestly  or ′ β rises  as the package size
increases, which could be taken as saying the markup falls with size. This result is illustrated
in Figure 6 which plots the size elasticity ′ β against package size for methamphetamine
prices. Although Caulkins and Padman imply that this is an instance in which there is a
distinct upward trend in ′ β , the majority of this “trend” is accounted for by the behaviour at
the two extremes of the weight range  weight class 1, on the one hand, and classes 11 and
12 on the other. For the other weight classes, that is, 210, which represent 75 percent of the
total number of classes, the elasticity is much more constant at around .75 (which implies a
discount elasticity of .25). This conclusion about the constancy of ′ β when we omit the
40
extremes would seem to be not inconsistent with the sampling variability of these estimates,
as indicated by the onestandard error band given in Figure 6.
10
TABLE 6
ESTIMATED DISCOUNT ELASTICITIES FOR HEROIN
(Standard errors in parentheses)
City Elasticity City Elasticity
1. Albuquerque .22 (.03) 23. New York/ New Jersey .29 (.07)
2. Atlanta .11 (.04) 24. New York/ Long Island .34 (.15)
3. Baltimore .28 (.04) 25. New York/ Bronx .22 (.07)
4. Boston .16 (.04) 26. New York/ Brooklyn .15 (.03)
5. Boulder .14 (.26) 27. New York/ Manhattan .17 (.02)
6. Buffalo .97 (.04) 28. Nashville .04 (.09)
7. Chicago .22 (.03) 29. New Orleans .27 (.02)
8. Cleveland .23 (.05) 30. Philadelphia .40 (.08)
9. Dallas .29 (.04) 31. Phoenix .29 (.02)
10. Denver .41 (.04) 32. Pittsburgh .01 (.17)
11. Detroit .17 (.02) 33. Portland .23 (.04)
12. Hartford .16 (.03) 34. San Antonio .20 (.04)
13. Honolulu .80 (.06) 35. San Francisco area .04 (.13)
14. Houston .41 (.03) 36. San Francisco .22 (.05)
15. Indianapolis .25 (.07) 37. Seattle .28 (.04)
16. Jacksonville .31 (.06) 38. St Louis .27 (.05)
17. Kansas City .32 (.04) 39. Tampa .34 (.31)
18. Los Angeles .15 (.02) 40. Tucson .43 (.03)
19. Memphis .42 (.06) 41. Washington D.C .21 (.04)
20. Miami .22 (.03) 42. Mean  unweighted .22
21. Milwaukee .46 (.19) 43. Mean  weighted .26
22. Minneapolis 1.56 (.31)
Source: Derived from Brown and Silverman (1974, Table 2).
Note: The weights in the weighted mean in row 43 are proportional to the reciprocals of
the standard errors.
10
For related research, see Rhodes et al. (1994).
41
TABLE 7
ESTIMATED DISCOUNT ELASTICITIES
FOR ILLICIT DRUGS
(Standard errors in parentheses)
Drug Elasticity
1. Marijuana  Imported .28
 Domestic .24
 Sinsmilla .15
 Hashish .23
 Mean .23
2. Crack .21 (.02)
3. Methamphetamine .21 (.01)
4. Black Tar Heroin .10 (.01)
5. Power Cocain .17 (.01)
6. White Heroin .17 (.02)
7. Brown Heroin .16 (.02)
8. Mean of rows 27 .17
Source: Derived from Caulkins and Padman (1993, Tables 3 and 4).
FIGURE 6
SIZE ELASTICITIES FOR METHAMPHETAMINES
Note: The solid line plots the estimated elasticity against package
size, while the broken lines give ± one standard error.
Source: Caulkins and Padman (1993, Figure 3).
Size elasticity ′ β
42
10. CONCLUDING COMMENTS
In many markets it is common for unit prices to decline as the quantity purchased rises, a
phenomenon which can be considered to be part of the economics of packaging. This paper
has reviewed the economic foundations of quantity discounts, proposed new ways of
measuring and analysing them, and carried out an empirical investigation involving the prices
of marijuana, as well as groceries and some other illicit drugs. The unit cost of marijuana
typically involves something like an 80percent discount when purchased in the form of
ounces than grams. As it is convenient to standardise for the magnitude of the quantity
difference in going from ounces to grams, we introduced the “size elasticity” β′ , the ratio of
the percentage change in the (total) price to the corresponding change in the package (or lot)
size. Another useful concept is the “discount elasticity” β, the percentage change in the unit
price resulting from a onepercent change in the size, which is related to the size elasticity
according to β = β′  1. Quantity discounts mean that the (total) price rises less than
proportionally with size, and the unit price falls, so that β′ < 1 and β < 0.
For marijuana our estimates of the discount elasticity are of the order of minus one
quarter, so the size elasticity is about three quarters. Table 8 provides a summary of all the
discount elasticities estimated or reviewed in the paper. As can be seen, the value for
marijuana of about minus one quarter is not too different from averages found in other
markets which pertain to both licit and illicit goods (groceries and drugs). This points in the
direction of concluding that just because a good is illegal, there is not necessarily anything
special about the manner in which it is priced; in this sense, economic forces transcend the
law. Accordingly, these sorts of products seem to be subject to the following pricing rule:
The price increases by 7.5 percent when the product size increases by 10 percent.
Or alternatively:
The unit price falls by 2.5 percent when the product size increases by 10 percent.
While such a rule has much appeal in terms of its elegant simplicity, it is probably a bit of an
exaggeration to claim that it has universal applicability. Although as an approximation the
rule seems work satisfactorily with the averages reported in Table 8, there is still considerable
dispersion among the underlying elasticities, as indicated in Figure 7. Thus rather than the
43
discount elasticity being in the class of a “natural constant”, it would seem more reasonable to
regard the value of .25 as having the status of the centre of gravity of this elasticity, at least
for the products considered in this paper.
Table 8
SUMMARY OF DISCOUNT ELASTICITIES
Source Elasticity
1. Mean ratio of standard deviation of marijuana prices to that of size .24
2. Marijuana pricing equation .24
3. Groceries pricing equation .23
4. Heroin .26
5. Marijuana  Caulkins and Padman .23
6. Other illicit drugs  Caulkins and Padman .17
Sources: 1. Row 1 is from panel C of Figure 4 (with the sign changed).
2. Row 2 is from panel B of Figure 5.
3. Row 3 is the average of the entries in panel I, column 3 of Table 5.
4. Row 4 is from the last entry of Table 6, the weighted mean.
5. Row 5 is from the fifth entry of the last column of Table 7.
6. Row 6 is from row 8 of Table 7.
FIGURE 7
HISTOGRAM OF ALL DISCOUNT ELASTICTIES
0
5
10
15
20
25
30
35
0.30 0.28 0.26 0.24 0.21 0.19 0.17 more
Range
Frequency
Mean=.24
44
APPENDIX
The Marijuana Data
11
The data on Australian marijuana prices were generously supplied by Mark Halzell,
of the Australian Bureau of Criminal Intelligence (ABCI). These prices were collected
by law enforcement agencies in the various states and territories during undercover buys.
In general, the data are quarterly and refer to the period 19901999, for each state and
territory. The different types of marijuana identified separately are leaf, heads,
hydroponics, skunk, hash resin and hash oil. However, we only focus on the prices of
“leaf” and “heads”, as these products are the most popular. The data are described by
ABCI (1996) who discuss some difficulties with them regarding different recording
practices used by the various agencies and missing observations.
The prices are usually recorded in the form of ranges and the basic data are listed in
Clements and Daryal (2001). The data are “consolidated” by: (i) Using the midpoint of
each price range; (ii) converting all gram prices to ounces by multiplying by 28; and (iii)
annualising the data by averaging the quarterly or semiannual observations. Plotting the
data revealed several outliers which probably reflect some of the abovementioned
recording problems. Observations are treated as outliers if they are either less than one
half of the mean for the corresponding state, or greater than twice the mean. These
observations are omitted and replaced with the relevant means, based on the remaining
observations. The data after consolidation and editing, for each state and territory are
given in Table A1 and A2 for leaf and heads, purchased in the form of grams and ounces.
The prices for Australia as a whole (given in the last column of the two tables) are
populationweighted means of the regional prices.
Table 1 of the text gives the discounts available if marijuana is purchased in the
form of ounces rather than grams. For the two products, the eight regions and Australia
as whole, these discounts are plotted against time in Figures A1 and A2. While the
discounts display considerable variability over time in some regions, most of this
“washes out” at the national level and the Australian discounts are fairly stable.
Further Results
Table 4 presents estimates of equation (8.2) for all regions and all years. Tables A3
and A4 present estimates of the analogous equation on a (i) yearbyyear basis and (ii)
regionbyregion basis. Figure 5 of the text is a histogram of these estimated discount
elasticities.
11
The first part of this section is from Clements (2002b) which, in turn, draws on Clements and Daryal
(2001).
45
TABLE A1
MARIJUANA PRICES: LEAF
(Dollars per ounce)
Region
Year NSW VIC QLD WA SA NT TAS ACT Australia
Purchased in the form of a gram
1990 770 735 700 802 700 700 910 630 748
1991 1,050 770 700 770 700 700 1,050 642 852
1992 1,060 700 630 700 560 700 700 630 797
1993 583 711 683 653 630 665 613 595 645
1994 998 698 648 700 630 665 443 753 780
1995 1,085 700 560 700 630 735 560 753 797
1996 1,400 793 665 753 630 788 508 700 950
1997 1,400 490 560 653 630 718 525 613 843
1998 1,097 735 630 467 653 683 467 723 798
1999 1,155 636 700 556 630 700 642 700 817
Mean 1060 697 648 675 639 705 642 674 803
Purchased in the form of an ounce
1990 438 513 225 210 388 275 313 413 390
1991 475 450 215 170 400 275 350 325 381
1992 362 363 188 340 225 300 188 350 313
1993 383 409 168 200 388 281 175 250 326
1994 419 394 181 288 325 244 170 400 341
1995 319 400 400 308 347 294 163 256 350
1996 325 383 350 283 350 263 200 408 340
1997 288 285 431 263 350 288 375 386 320
1998 333 363 375 250 350 300 375 450 344
1999 275 313 444 250 350 300 262 450 322
Mean 362 387 298 256 347 282 257 369 342
46
TABLE A2
MARIJUANA PRICES: HEADS
(Dollars per ounce)
Region
Year NSW VIC QLD WA SA NT TAS ACT Australia
Purchased in the form of a grams
1990 1,120 1,050 1,400 1,120 1,400 700 910 840 1,160
1991 1,120 1,120 1,400 962 1,400 700 1,120 840 1,167
1992 1,400 1,120 910 770 700 700 1,225 770 1,103
1993 863 665 858 840 1,173 700 927 747 834
1994 1,155 770 1,068 840 1,120 770 735 980 993
1995 1,190 793 843 749 1,138 793 1,155 1,033 974
1996 1,171 840 771 704 910 840 963 1,400 946
1997 1,400 858 630 700 840 863 700 793 977
1998 1,120 840 723 630 840 823 723 840 889
1999 1224 630 589 560 840 840 630 1006 842
Mean 1,176 869 919 788 1,036 773 909 925 989
Purchased in the form of an ounce
1990 600 650 413 600 400 325 525 463 558
1991 600 550 425 502 200 325 450 375 504
1992 375 450 388 390 363 450 425 500 401
1993 500 348 363 431 450 363 344 383 419
1994 550 367 328 400 425 325 363 550 433
1995 538 400 320 354 438 358 350 438 430
1996 550 400 398 325 406 283 388 525 445
1997 550 400 538 300 400 358 383 442 466
1998 488 388 550 275 340 325 367 450 437
1999 513 400 300 250 400 300 325 479 404
Mean 526 435 402 383 382 341 392 461 449
47
FIGURE A1
DISCOUNT FOR BULK BUYING: LEAF
(100 × logarithmic ratios of ounce to gram prices)
NSW
160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
VIC
160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
QLD
160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
WA 160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
AUSTRALIA
160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
ACT 160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
NT
160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
SA
160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
TAS 160
110
60
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
48
FIGURE A2
DISCOUNT FOR BULK BUYING: HEADS
(100 × logarithmic ratios of ounce to gram prices)
AUSTRALIA
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
NSW
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
VIC
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
QLD
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
WA
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
SA
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
NT
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
TAS
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
ACT
200
150
100
50
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
49
TABLE A3
MARIJUANA PRICE EQUATIONS BY YEAR
r r
s
log p logs regional and product dummies = α + β +
(Standard errors in parentheses)
Year Constant Discount
elasticity
Regional dummy
R
2
SEE
α β
Leaf dummy
VIC QLD WA SA NT TAS ACT
No. of
obs.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
I. Leaf
1990 6.765 (.193) .241 (.039) .056 (.258) .381 (.258) .347 (.258) .108 (.258) .280 (.258) .084 (.258) .130 (.258) .863 .258 16
1991 7.016 (.179) .274 (.036) .182 (.239) .599 (.239) .669 (.239) .289 (.239) .476 (.239) .153 (.239) .436 (.239) .911 .239 16
1992 6.887 (.140) .275 (.028) .206 (.187) .588 (.187) .239 (.187) .557 (.187) .301 (.187) .535 (.187) .277 (.187) .942 .187 16
1993 6.597 (.198) .264 (.040) .132 (.265) .333 (.265) .268 (.265) .045 (.265) .089 (.265) .367 (.265) .203 (.265) .879 .265 16
1994 6.900 (.123) .257 (.025) .210 (.164) .636 (.164) .365 (.164) .357 (.164) .473 (.164) .857 (.164) .164 (.164) .955 .164 16
1995 6.800 (.174) .254 (.035) .106 (.233) .218 (.233) .237 (.233) .230 (.233) .236 (.233) .666 (.233) .293 (.233) .899 .233 16
1996 6.949 (.165) .261 (.033) .202 (.220) .335 (.220) .379 (.220) .362 (.220) .393 (.220) .750 (.220) .233 (.220) .916 .220 16
1997 6.803 (.227) .210 (.045) .530 (.303) .257 (.303) .427 (.303) .302 (.303) .334 (.303) .358 (.303) .266 (.303) .781 .303 16
1998 6.728 (.150) .194 (.030) .157 (.200) .218 (.200) .570 (.200) .234 (.200) .289 (.200) .368 (.200) .058 (.200) .883 .200 16
1999 6.720 (.169) .232 (.034) .234 (.225) .011 (.225) .413 (.225) .182 (.225) .207 (.225) .318 (.225) .004 (.225) .885 .225 16
Continued on next page
50
TABLE A3 (continued)
MARIJUANA PRICE EQUATIONS BY YEAR
r r
s
log p logs regional and product dummies = α + β +
(Standard errors in parentheses)
Year Constant Discount
elasticity
Regional dummy
R
2
SEE
α β
Leaf dummy
VIC QLD WA SA NT TAS ACT
No. of
obs.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
II. Heads
1990 7.091 (.161) .229 (.032) .008 (.214) .075 (.214) .000 (.214) .091 (.214) .542 (.214) .171 (.214) .273 (.214) .898 .214 16
1991 7.185 (.234) .285 (.047) .044 (.312) .061 (.312) .165 (.312) .438 (.312) .542 (.312) .144 (.312) .379 (.312) .861 .312 16
1992 6.982 (.161) .238 (.032) .020 (.215) .198 (.215) .279 (.215) .363 (.215) .255 (.215) .004 (.215) .155 (.215) .896 .215 16
1993 6.862 (.087) .225 (.017) .312 (.116) .163 (.116) .088 (.116) .101 (.116) .265 (.116) .151 (.116) .205 (.116) .964 .116 16
1994 7.088 (.099) .245 (.020) .405 (.132) .298 (.132) .318 (.132) .144 (.132) .466 (.132) .434 (.132) .082 (.132) .962 .132 16
1995 7.122 (.086) .263 (.017) .351 (.114) .432 (.114) .441 (.114) .125 (.114) .407 (.114) .230 (.114) .174 (.114) .974 .114 16
1996 7.108 (.075) .252 (.015) .325 (.100) .371 (.100) .517 (.100) .278 (.100) .498 (.100) .272 (.100) .066 (.100) .980 .100 16
1997 7.122 (.131) .207 (.026) .404 (.175) .410 (.175) .650 (.175) .415 (.175) .457 (.175) .528 (.175) .394 (.175) .917 .175 16
1998 6.971 (.112) .219 (.022) .258 (.150) .159 (.150) .574 (.150) .325 (.150) .357 (.150) .361 (.150) .184 (.150) .942 .150 16
1999 7.049 (.089) .224 (.018) .456 (.119) .634 (.119) .750 (.119) .313 (.119) .456 (.119) .560 (.119) .132 (.119) .970 .119 16
Continued on next page
51
TABLE A3 (continued)
MARIJUANA PRICE EQUATIONS BY YEAR
r r
s
log p logs regional and product dummies = α + β +
(Standard errors in parentheses)
Year Constant Discount
elasticity
Leaf dummy
Regional dummy
R
2
SEE
α β VIC QLD WA SA NT TAS ACT
No of obs
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
III. Leaf and Heads
1990 7.109 (.125) .235 (.024) .361 (.079) .032 (.158) .228 (.158) .174 (.158) .100 (.158) .411 (.158) .128 (.158) .202 (.158) .855 .224 32
1991 7.239 (.148) .280 (.028) .278 (.094) .113 (.187) .330 (.187) .417 (.187) .363 (.187) .509 (.187) .148 (.187) .407 (.187) .846 .265 32
1992 7.102 (.111) .256 (.021) .335 (.070) .113 (.140) .393 (.140) .259 (.140) .460 (.140) .278 (.140) .270 (.140) .216 (.140) .894 .199 32
1993 6.894 (.117) .244 (.022) .329 (.074) .090 (.147) .248 (.147) .178 (.147) .073 (.147) .177 (.147) .259 (.147) .204 (.147) .873 .208 32
1994 7.156 (.092) .251 (.017) .323 (.058) .307 (.116) .467 (.116) .342 (.116) .251 (.116) .470 (.116) .645 (.116) .123 (.116) .927 .165 32
1995 7.104 (.111) .258 (.021) .286 (.070) .229 (.140) .325 (.140) .339 (.140) .177 (.140) .321 (.140) .448 (.140) .233 (.140) .892 .198 32
1996 7.144 (.104) .257 (.020) .231 (.066) .264 (.131) .353 (.131) .448 (.131) .320 (.131) .446 (.131) .511 (.131) .083 (.131) .905 .185 32
1997 7.075 (.116) .208 (.022) .226 (.073) .467 (.146) .333 (.146) .538 (.146) .358 (.146) .395 (.146) .443 (.146) .330 (.146) .841 .207 32
1998 6.930 (.083) .207 (.016) .161 (.052) .208 (.105) .188 (.105) .572 (.105) .280 (.105) .323 (.105) .364 (.105) .121 (.105) .910 .148 32
1999 6.934 (.099) .228 (.019) .099 (.063) .345 (.125) .322 (.125) .582 (.125) .248 (.125) .332 (.125) .439 (.125) .068 (.125) .891 .177 32
Notes: NSW is the base for the regional dummies. The leaf dummy takes the value one for leaf and zero otherwise.
52
TABLE A4
MARIJUANA PRICE EQUATIONS BY REGION
st t
log p logs time and product dummies = α + β +
(Standard errors in parentheses)
Region Constant Discount
elasticity
Leaf
dummy
Time Dummy
R
2
SEE No. of
obs.
α β 1991 1992 1993 1994 1995 1996 1997 1998 1999
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
I. Leaf
NSW 6.895 (.205) .318 (.037) .196 (.277) .065 (.277) .206 (.277) .108 (.277) .013 (.277) .150 (.277) .089 (.277) .040 (.277) .030 (.277) .895 .277 20
VIC 6.716 (.058) .178 (.011) .042 (.079) .197 (.079) .130 (.079) .158 (.079) .149 (.079) .108 (.079) .497 (.079) .173 (.079) .319 (.079) .974 .079 20
QLD 6.404 (.229) .253 (.042) .023 (.309) .143 (.309) .158 (.309) .147 (.309) .176 (.309) .195 (.309) .213 (.309) .203 (.309) .340 (.309) .827 .309 20
WA 6.506 (.148) .293 (.027) .126 (.199) .173 (.199) .127 (.199) .090 (.199) .123 (.199) .118 (.199) .010 (.199) .183 (.199) .096 (.199) .934 .199 20
SA 6.566 (.059) .186 (.011) .015 (.079) .384 (.079) .053 (.079) .141 (.079) .109 (.079) .104 (.079) .104 (.079) .086 (.079) .104 (.079) .974 .079 20
NT 6.543 (.044) .275 (.008) .000 (.059) .044 (.059) .015 (.059) .085 (.059) .058 (.059) .037 (.059) .036 (.059) .031 (.059) .044 (.059) .993 .059 20
TAS 6.745 (.196) .279 (.035) .127 (.264) .386 (.264) .488 (.264) .665 (.264) .569 (.264) .515 (.264) .185 (.264) .243 (.264) .263 (.264) .898 .264 20
ACT 6.544 (.111) .186 (.020) .110 (.149) .083 (.149) .280 (.149) .073 (.149) .150 (.149) .047 (.149) .047 (.149) .112 (.149) .096 (.149) .916 .149 20
Continued next page
53
TABLE A4 (continued)
MARIJUANA PRICE EQUATIONS BY REGION
st t
log p logs time and product dummies = α + β +
(Standard errors in parentheses)
Region Constant Discount
elasticity
Leaf
dummy
Time Dummy
R
2
SEE No. of
obs.
α β 1991 1992 1993 1994 1995 1996 1997 1998 1999
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
II. Heads
NSW 7.111 (.114) .241 (.021) .000 (.153) .123 (.153) .221 (.153) .028 (.153) .024 (.153) .021 (.153) .068 (.153) .103 (.153) .034 (.153) .941 .153 20
VIC 7.062 (.072) .207 (.013) .051 (.097) .152 (.097) .541 (.097) .441 (.097) .383 (.097) .354 (.097) .344 (.097) .370 (.097) .498 (.097) .973 .097 20
QLD 7.036 (.194) .241 (.035) .014 (.262) .247 (.262) .309 (.262) .251 (.262) .381 (.262) .317 (.262) .267 (.262) .187 (.262) .593 (.262) .860 .262 20
WA 7.077 (.041) .221 (.007) .165 (.055) .403 (.055) .309 (.055) .347 (.055) .465 (.055) .539 (.055) .582 (.055) .678 (.055) .784 (.055) .993 .055 20
SA 7.114 (.196) .298 (.036) .347 (.265) .395 (.265) .030 (.265) .081 (.265) .058 (.265) .208 (.265) .255 (.265) .337 (.265) .255 (.265) .894 .265 20
NT 6.578 (.097) .247 (.018) .000 (.131) .163 (.131) .055 (.131) .048 (.131) .111 (.131) .022 (.131) .153 (.131) .081 (.131) .051 (.131) .957 .131 20
TAS 6.952 (.113) .248 (.021) .027 (.153) .043 (.153) .202 (.153) .291 (.153) .084 (.153) .123 (.153) .289 (.153) .294 (.153) .424 (.153) .949 .153 20
ACT 6.779 (.084) .206 (.015) .105 (.114) .005 (.114) .154 (.114) .163 (.114) .076 (.114) .318 (.114) .052 (.114) .014 (.114) .107 (.114) .959 .114 20
Continued next page
54
TABLE A4 (continued)
MARIJUANA PRICE EQUATIONS BY REGION
st t
log p logs time and product dummies = α + β +
(Standard errors in parentheses)
Region Constant Discount
elasticity
Leaf
dummy
Time Dummy
R
2
SEE No.
of
obs.
α β 1991 1992 1993 1994 1995 1996 1997 1998 1999
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16)
III. Leaf and Heads
NSW 7.130 (.110) .280 (.019) .254 (.063) .098 (.142) .029 (.142) .214 (.142) .040 (.142) .006 (.142) .064 (.142) .079 (.142) .032 (.142) .032 (.142) .895 .201 40
VIC 6.969 (.069) .193 (.012) .161 (.040) .047 (.089) .174 (.089) .335 (.089) .299 (.089) .266 (.089) .231 (.089) .420 (.089) .271 (.089) .409 (.089) .920 .125 40
QLD 6.886 (.158) .247 (.027) .331 (.091) .004 (.204) .195 (.204) .234 (.204) .199 (.204) .103 (.204) .061 (.204) .027 (.204) .008 (.204) .126 (.204) .778 .289 40
WA 6.925 (.110) .257 (.019) .267 (.063) .146 (.142) .115 (.142) .218 (.142) .128 (.142) .171 (.142) .211 (.142) .286 (.142) .430 (.142) .440 (.142) .886 .200 40
SA 6.976 (.114) .242 (.020) .272 (.066) .166 (.147) .390 (.147) .041 (.147) .111 (.147) .083 (.147) .156 (.147) .180 (.147) .211 (.147) .180 (.147) .863 .208 40
NT 6.629 (.050) .261 (.009) .137 (.029) .000 (.065) .103 (.065) .020 (.065) .019 (.065) .084 (.065) .029 (.065) .094 (.065) .056 (.065) .047 (.065) .971 .092 40
TAS 7.055 (.125) .264 (.022) .414 (.072) .077 (.162) .172 (.162) .345 (.162) .478 (.162) .326 (.162) .319 (.162) .237 (.162) .269 (.162) .344 (.162) .877 .229 40
ACT 6.796 (.070) .196 (.012) .269 (.040) .108 (.090) .044 (.090) .217 (.090) .118 (.090) .037 (.090) .182 (.090) .050 (.090) .049 (.090) .101 (.090) .924 .127 40
Note: 1990 is the base for the time dummies. The leaf dummy takes the value of one for leaf and zero otherwise.
55
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2 1. INTRODUCTION
Over the 1990s in Australia, the average price of a gram of marijuana was about $A35, while an ounce cost $449. As there are 28 grams in an ounce, this means that the per ounce cost of a gram was 28 × 35 = $980, or more than twice the cost when marijuana was purchased in the form of an ounce. Put another way, there is a substantial discount for purchasing marijuana in bulk, or a premium for smaller purchases. This paper deals with the measurement and understanding of these sorts of quantity discount. One explanation for the phenomena of quantity discounts is the role of risk. Suppose a dealer has, say, ten ounces of marijuana to sell and is faced with the alternative of making either ten individual sales of one ounce each, or 280 gram sales. The latter marketing strategy could possible run the risk of greater exposure of the illicit drug operation. If the dealer has contact with a larger number of people, this could possibly increase the risk of apprehension, increasing the expected value of a penalty from the justice system. More generally, as the activities of larger dealers could possibly be more hidden from the law, they do not have to spend so much investing in “security”. On the other hand, dealers on the street may have to either bribe police or engage in expensive security arrangements to be able to stay in business. Sjaastad (2003) argues that “[t]he gangs here in Chicago, which dominate the drug trade, maintain rather expensive organisations to keep them in motion and they face a lot of competition as there is free entry into the street business. On the other hand, the bulk dealers are likely to be part of a cartel, which has no competition.” These considerations all lead to the unit cost of illicit drugs increasing as the size of the sale falls. A completely different explanation of quantity discounts involves the value added as the product moves through the supply chain. The “conversion” of marijuana from ounce to gram lot sizes is not a costless operation, and can be thought of as analogous to the economic role played by any retailing business such as a service station which sells petrol to motorists. The economic function performed by a service station is the transformation of tanker loads of petrol into smaller lot sizes suitable for individual cars. As this activity is valued by consumers, they are willing to pay for it in the form of petrol prices at the bouser that are considerably higher than the wholesale price.
3 Accordingly, the quantity discount that the service station receives when it purchases petrol from the wholesaler is its retail margin that simultaneously represents consumers’ valuation of the economic function it performs, as well as its value added. Thus to make 280 gram sales of marijuana, rather than ten sales of one ounce each, would be a more costly way of marketing the product, due to the time and effort associated with splitting ounces to grams, and the need to service a larger number of customers individually. A third explanation of quantity discounts relates to pricing strategies of firms with market power. In cases where larger buyers have a more elastic demand for the product and resale can be prevented, then the discounts they receive may be a manifestation of price discrimination by a powerful supplier. For arguments along these lines, see, e.g., Mills (1996, 2002). This paper introduces new ways of measuring and analysing quantity discounts, with an emphasis on the marijuana market. Section 2 explores in some detail alternative approaches to the problem. Section 3 discusses the discounts available for purchasing marijuana in bulk, while the concept of the “discount” is formalised in Section 4 in terms of what we call the “size” and “discount” elasticities of prices. In Section 5 we present a novel way of extracting estimates of the discount elasticity from the distribution of prices. Sections 6 and 7 deal with the econometrics of packaging, and the procedures discussed therein are implemented in Section 8 with marijuana prices. Section 9 considers pricing practices in other markets, including groceries. Concluding comments are contained in Section 10.
2. ALTERNATIVE APPROACHES TO PACKAGE PRICING
This section considers several different approaches to understanding aspects of the economics of package pricing. TwoPart Pricing Consider a product whose price is related to the cost of its package size and the volume of the product. Following Telser (1978, Sec. 9.4), let s denote the volume of the
4 product in the package, so that
s1
3
is proportional to the linear dimension of the
package and the square of this, s 2 3 , is proportional to the area of the package surface. The cost of the contents of the package is proportional to the volume, α s , while the cost of the packaging is proportional to the area, β s 2
3
. Suppose that as an approximation, the
price of a package of size s , p , is the sum of these two costs:
(2.1)
p = α s + β s2 3 .
The price per unit of the product is
(2.2)
p s = α + β s1 3 .
This shows that unit price declines with package size, as the package cost increases less than proportionately to the volume of the product. The declining unit price result can also be expressed in terms of the elasticity of price with respect to size. If this elasticity is less than unity, then the per unit price falls. It follows from equation (2.1) that the effect on package price of an increase in size is ∂ p ∂ s = α + ( 2β 3) s 1 3 . Thus price increases with size, but at a decreasing rate. Let η denote the size elasticity ∂ ( log p ) ∂ ( log s ) =
(∂ p
∂ s)
(p s) .
It follows from the above expression for the marginal effect and
equation (2.2) for the corresponding average that the size elasticity takes the form
(2.3)
η=
α + ( 2β 3) s1 α + β s1
3
3
.
As the numerator is clearly less than the denominator, the elasticity is less than unity. Next, suppose there is a cost per transaction that is independent of the price and package size. This fixed cost could be associated with the processing of the sale, and/or other administrative expenses. Then, if γ is the fixed cost, equations (2.1) and (2.2) become
5 p = γ + α s + β s2 3 ,
p s = α + γ (1 s ) + β s1 3 ,
and the size elasticity takes the form
α + ( 2β 3) s 1
3 3
(2.4)
η=
α + γ (1 s ) + β s 1
.
As there is an additional positive term in the denominator of (2.4), γ (1 s ) , the value of the elasticity is now lower than before. This is because as the transaction cost is fixed, it is spread over a larger base as size increases, and the proportionate effect of size on price is now lower. A MultiStage Supply Chain Consider an individual who purchases an ounce of marijuana and then splits it into 28 gram packets to sell. What can be said about the relationship between the ounce price and the gram price? As the seller of ounces and grams may be the same person, we could consider the relationship between the two prices to be determined by an arbitrage condition, according to which the seller is indifferent between the form in which the product is sold. This issue has wider applicability than to just the market for illicit drugs, as analytically exactly the same considerations apply to packaging decisions pertaining to legal products, such as selling rice by the kilo or half kilo. As for many products wholesale transactions involve larger volumes than retail, the issue is also similar to the spread between wholesale and retail prices. We thus proceed with some generality and consider a generic step in a multistage supply chain. Let pi1 be the price of a good sold at step i − 1 in the supply chain, such as the price of an ounce of marijuana sold in the form of an ounce. Then if q i −1 is the corresponding quantity, pi −1q i −1 is total revenue derived from step i − 1 . This revenue is to be compared to the costs of selling q i −1 at step i − 1 . Suppose these are made up of material costs plus processing and selling expenses; denote these costs per unit by ci1. Total cost is ci −l q i −1 ,
and profit is (2.5)
pi −1 q i −l − ci − l q i −1 .
It still seems reasonable however that this cost falls less than proportionately than the quantity transacted si . so that the cost per gram of marijuana when sold in the form of ounces. Note that ci −1 and cisi are the costs of materials.1 . is equalised at each step in the chain: The profit from processing and selling an ounce of marijuana is equal to 28 times that of processing and selling a gram.6).7) ci si > ci1 . appropriately adjusted for the differing quantities transacted.8) has .5). Thus equating (2. arbitrage will ensure that profits at each step are equalised. where ci is the overall per unit cost at step i. the only cost were a constant fixed cost for each sale. processing and selling exactly the same volume of the product at successive steps in the supply chain. the overall cost associated with one sale of an ounce of marijuana is less than that of 28 distinct sales of 1 gram each.ci1 = si ( pi . In words.ci ) . q i −l . In terms of the units at step i . the profit from selling the same quantity involved in (2. But this is an extreme case. in terms of the units at i . si = 28 . and in all likelihood per unit cost would fall with the volume transacted. then ci = ci − 1 and ci si > ci . In transforming marijuana from ounces into grams at step i.6) pi si q i −1 − ci si q i − l . We shall thus assume that (2. si is the package size at the previous step.6 Suppose at the next stage of the marketing chain the product is processed further and then split such that the unit sold is now as a multiple 1/ si < 1 of that at the previous step. for example.1 as si > 1. in the form of smaller units is (2.5) and (2. we obtain (2. ci −1 / si . If entrepreneurs have a choice regarding where in the supply chain they locate. If. so that ci < ci . so that the netofcost price. With pi the price at this step (dollars per gram).8) pi1 .1 . is less than the same cost when sold in the form of grams ci . Equation (2. 1 si is the size at i .
Accordingly. agricultural prices at the farmgate level generally exhibit more volatility than their retail counterparts.si ci + ci1 and then in Figure 1 plot pi1 against si pi .7) the elasticity of the price at stage i1 in the chain with respect to the price at stage i is greater than unity. by successive substitution it is possible to use equation (2.8) can be revealed if we write it as pi . More generally. is less as long as condition (2. under (2. we write it in the form pi1 = si pi . Third. while the slope of a ray from the origin to any point on the curve. The slope of the curve AB is 45º.7 several interesting implications.7) is satisfied.ci1 )(1 si ) . si pi A second implication of equation (2. As the elasticity is the ratio of the slope of the curve to the slope of the ray. for example.ci = (1 si )( pi1 . such as OC. or pi = ci + ( pi1 .ci1 ) . First. (2. FIGURE 1 PRICES AT TWO STEPS IN THE SUPPLY CHAIN Price at step i1 pi1 pi1 = si ci + ci1 + si pi B C A 45o O s i c i − c i −1 Price at step i.9) to express the price at any step in the supply chain in terms of the characteristics of all previous steps as . This agrees with the observation that retail prices of meat.9) We see that the price is the sum of a fixed cost per transaction plus a variable cost related to the quantity in the package. the volatility of prices is amplified as we move back through the supply chain. are much more stable than livestock prices.
such a shock has a dampened impact due to the splitting of the product at each step.10) thus reveals how a shock to the price at the basic level in the chain is transmitted to all higher levels.7) implies that d i1. d i1. k=0 n 1 (2. In words. If this were to describe the operation of the marijuana supply chain. The relationship between the size elasticity and quantity discounts will be discussed subsequently in Section 4.i = c′ ( ci −1 ci si − 1) . grams . If we write the discount as a function of the package size. The term pi −1 is then the price if we buy an ounce of marijuana in the form of an ounce. ounces . away from its basic source.10) simplifies to ∏ n −1 (1 si − k ) = (1 s ) . It follows from equation (2. i < 0 .i = f ( si ) . but at a decreasing rate. 28 × ounces .n ) ∏ (1 si . In this situation. Equation (2.k ) < 1 for all k .si pi ) / si pi is the proportionate quantity discount available in the transition from step i1 to i. Condition i i (2.10) where n is the number of steps in the chain before step i . Consider again the case of marijuana with processing of ounces into grams. As it travels up through the chain. then f ′ < 0 and f ′′ > 0 . the last term on the righthand side of equation (2. so that si = s . the discount increases (in absolute value). k =0 n Finally. where c′ = ci / pi is the proportionate cost at step i .8) that the discount takes the form d i −1. the volume transacted at successive steps would be … 282 × ounces .k ) . appropriately discounted to reflect the economic distance that the product has travelled up the supply chain.8) has implications for the nature of quantity discounts.i ≡ ( pi1 .8 pi = ci + ( pi .ci . net of basic costs. Accordingly.n . while si pi is the cost of the same quantity if purchased in the form of 28 lots of gram packages. that is. d i −1. equation (2. . Consider the special case where the product is divided by the same amount at each step. as (1 si . as the package size rises. Thus the price at step i comprises (i) unit costs at this step and (ii) the price of the “basic” product. ∏ n −1 (1 si − k ) k =0 1 .
A component of this overall cost is the cost of the product at the previous step. Thus.8).9 A related way of modelling the operation of the marketing chain.11) has on the lefthand side the price in terms of the unit transacted at step i (such as dollars per gram). we have (2.1 si . the elasticity of pi with respect to pi . processing and selling at step i . (2. But such an approach is misguided as the steadystate is never reached because the markup δ is presumably always greater than unity. then the price is linked to costs according to: (2. This amounts to the elasticity of pi .1 is less than unity.1 si .δ ) . see the discussion below equation (2.12) p ( s ) = α sβ . pi .11) are both positive.11) p i = δ i ci + p i . which does not rely on an arbitrage condition.1 with respect to pi being greater than unity. Writing p (s) for price as a function of size. In the above formulation the unit cost ci represents the costs of materials. If δi is the markup factor at stage i . It is therefore tempting to analyse the solution to this equation and declare that the natural end to the supply chain occurs when the price hits its steadystate value of δ c (1 .1 s i . This subsection sets out this approach. In particular. . where α = exp (α′) . is as follows. and “other” costs ci . their approach relates the size elasticity of price to some more basic features of the packaging business.11) could be considered as a firstorder difference equation in the price measured in a common unit. Suppose there is a loglinear relationship between price and package size. We now decompose the overall cost into the cost of the product used as input.1 A LogLinear Model Caulkins and Padman (1993) propose a model which gives some further insight into the relationship between price and package size. ( ) As δi and ci in equation (2. where α ′ is an intercept and β is the size elasticity. so that ci = ci + pi . One alternative way of proceeding would be to treat the markup as endogenously determined such that the chain ends when δ falls below unity as a result of the forces of competition. log p = α ′ + β log s . while on the right is the price at the previous step in terms of the same unit (the ounce price expressed in the form of dollars per gram). the same result as before. Suppose that initially an ounce of marijuana is purchased and that we 1 Equation (2.
δ = 1 and the size elasticity β = 1 . If this ounce is then split into 28 gram packages. the unit price falls with the quantity purchased.13) β becomes φ α ( s φ ) . the revenue from these 28 packages is 28 × p (1) .12) again.10 measure size in terms of grams. we use equation (2. The role of the conversion factor in equation (2. In other words. or φ( β 1β ) = δ. we can write the righthand side of (2. so does the quantity discount and the (proportionate) increase in the total price resulting from a unit increase in package size is lower. Thus we have the following general relationship between prices of different package sizes. the size elasticity β falls with the markup. Define the ratio of this revenue to the cost of an ounce as the markup factor.14) is then to normalise .13) to derive an expression for the size elasticity β that involves the markup and conversion factors δ and φ . in the previous example φ = 28 . so that price is just proportional to package size and there would be no quantity discount for buying in bulk. the more the product can be “split” or “cut” and the higher is the profit from the operation. or 28 × p (1) = δ × p (28) . the markup and conversion factors: s φ × p = δ × p (s) . log φ (2. If there is no markup. Accordingly. δ = 28 × p (1) p (28) . More generally. Other things equal.13) Our objective is to use equations (2. so that discounts would apply.12) in the form p ( s φ ) = α ( s φ ) . which implies log δ . let φ > 1 be the conversion factor that transforms the larger quantity s into a smaller one s φ . As the markup rises.13) β as δ α sβ . To do this. so that s = 28 and p (28) is the price of this ounce.12) and (2. equation (2.14) β= 1  Equation (2. the greater the conversion factor φ .14) shows that the size elasticity falls with the markup δ and rises with the conversion factor φ . so that s = 1 now. Using equation (2.13) can be expressed as φ ( s / φ ) = δ sβ . φ (2. so that the lefthand side of equation (2. where p (1) is the price of one gram. When δ > 1 .
In other words. With these values. so that a doubling of package size is associated with an 80 percent increase in price.14).11 by deflating the markup by the size of the conversion involved (e. To illustrate the workings of equation (2. 124) argues that a quantity discount can also be consistent with price discrimination if not all of the cost savings associated with a larger quantity are passed onto consumers. whereby unit prices increase with package size. 122) argues that “… manufacturers probably believe that a significant proportion of customers will nevertheless choose that size . Mills (p. thus making the size elasticity a pure number. about 9 percent of cases represented quantity surcharges and these were concentrated in five product groups: Toothpaste for which 33 percent of cases were surcharges.2 Overall. Here subtle forms of price discrimination are practiced by charging different classes of consumers of a given good a different unit price.log 2 log 28 ≈ 0. 1987.750 prices for 149 products sold at Sydney supermarkets. Equation (2. pp.8 . 121127) studied about 1. We shall return to Mills’ data in Section 9 below. the opposite to the more familiar case of discounts for larger quantities. 3 For a further analysis. pp. β = 1 . Gerstner and Hess. so that δ = 2 . snack foods (19 percent). see Mills (1996). To account for the observed surcharge on the largest package size of toothpaste. 1984. canned meat (33 percent).g. Pricing Strategies A branch of the literature views the pricepackage relationship as part of producers’ competitive strategy. In a number of instances he found quantity surcharges. and we convert from ounces to grams. or because the customers think (without checking) that there will be a quantity discount”. Such practises are inconsistent with competitive markets. b). Moreover. in which case φ = 28 . as discussed by Mills (2002. .14) is an elegant result which yields some additional understanding of the interactions between price and package size. and there must be some form of barrier (real or artificial) preventing arbitrage between the different classes of consumers. suppose that the markup is 100 percent. Walker and Cude 1984 and Widrick.. flour (23 percent).on grounds of convenience. Mills (2002. in going from ounces to grams). Mills (p. 119120).3 2 Quantity surcharges have also been identified in several earlier studies (Cude and Walker. 1979a. and paper tissues (19 percent). toothpaste manufacturers probably practice price discrimination. as prices do not reflect costs.
indicating that the unit price for ounce purchases are less than those for gram purchases. leaf and heads. 3. unit price differences reflect equalising price differences. for example. rather than price discrimination. The difference between the regular and the sales price represents the cost of storage to the sellers and is therefore an equalising price difference. since he cannot expect the same effect on his rates of sale to them for given price reductions without regard to their timing. As can be seen. It is most emphatically not an example of price discrimination. with the negative signs confirming the presence of discounts. the corresponding mean for heads is 79 percent. all the observations lie below the 45° line. When there is a large price decrease. ounces and grams. Those who buy small amounts frequently will not buy much more at temporarily lower prices. On the contrary. we see that for Australia as a whole on average there is an 85 percent discount from buying ounces rather than grams. Table 1 presents the quantity discounts in logarithmic form. Looking at the last entry in the last column for leaf (panel I of the table). 339). see the Appendix. Such buyers will have a relatively steady demand over time. For a listing of the data and further details. As all prices are expressed in terms of dollars per ounce. to be precise).12 Others argue that in some instances. it is a price pattern consistent with a competitive market. p. discusses the case of those who buy larger quantities less frequently and pay lower unit prices: Assume that the retailer has two kinds of customers for some product. These data were supplied by the Australian Bureau of Criminal Intelligence and refer to the period 199099 and the eight states and territories of Australia. there is a large sales increase to those who are willing to store the good. . it should be kept in mind that to gain such a discount a substantially larger purchase must be made (28 times larger. The behaviour of these customers impose a constraint on the retailer. Hence sellers hold larger stocks relative to the mean rate of sales for the light buyers than for the heavy buyers. customers who buy large amounts for their inventory and customers who buy small amounts more frequently. they are directly comparable. MARIJUANA PRICES In this section we present data on marijuana prices purchased in the form of two package sizes. Sales to this group drop sharply after the price reduction and may subsequently return to the normal level. Figure 2 (which has the same format as Figure 1) plots the ounce price against the gram price for two broad types of marijuana. While these are clearly substantial discounts. Telser (1978.
4 In a conventional histogram. each observation is equally weighted and the vertical axis records the number of observations falling in each bin. The combined histogram is unimodal. The two products leaf and heads are combined by weighting them according to their relative importance in consumption. heads (panel B) and leaf and heads combined (panel C).13 FIGURE 2 OUNCE AND GRAM PRICES OF MARIJUANA (Dollars per ounce) A. 13 Gram price 0 70 0 90 0 00 00 00 00 0 0 0 0 0 .3 and . weighted according to the above scheme and then the weighted number of observations is recorded on the vertical axis. Leaf Ounce price 1300 1100 900 700 500 300 100 0 10 45° B. Accordingly. 2002a)4. 2002a). For the weighted version. respectively (Clements. the area of a given column of the weighted histogram is proportional to the productweighted importance of the observations that fall within the relevant bin. somewhat less “raggard” than the other two and the mean discount is about 80 percent. observations in each bin are sorted into the two products. Heads Ounce price 1300 1100 900 700 500 300 100 50 10 45° 0 30 30 70 11 13 90 50 11 Gram price In Figure 3 we plot the discounts for leaf (in panel A).7. guesstimated to be . such as panel C of Figure 3. Note also that all three histograms seem to have long lefthand tails. (at about –70 percent). which probably reflects the high variability of the underlying data (Clements.
2 61.2 82.1 119.9 89.0 71.4 74.4 131.1 96.8 123.1 93.5 62.5 79.3 47.0 86.8 58.5 68.9 45.2 76.3 84.4 82.2 56.8 61.0 82.8 54.0 118.2 113.3 57.7 76.4 83.8 85.2 26.6 58.9 131.3 107.1 122.8 27.5 80.2 65.14 TABLE 1 DISCOUNT FOR BULK BUYING OF MARIJUANA (100 × logarithmic ratios of ounce to gram prices) Year NSW VIC QLD Region WA SA I.9 60.3 79.2 99.1 42.6 43.7 91.2 86.5 119.4 79.5 84.4 74. Heads 93.9 54.8 98.6 80.1 97.2 55.3 107.7 83.1 36.8 82.8 75.2 68.7 82.4 146.5 106.6 82.9 62.6 21.0 81.2 68.2 68.2 66.7 109.4 95.4 58.3 84.7 86.7 44.5 70.7 91.4 93.2 33.1 58.0 71.4 62.2 105.2 64.0 158.4 74.1 87.3 91.7 86.8 74.7 95.7 74.7 74.1 100.6 .3 127.3 194.2 70.9 65.4 42.4 90.9 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 62.8 86.7 55.8 59.4 62.2 85.0 56.8 57.2 90.1 68.5 80.6 59.4 82.9 59.8 88.0 101.4 69.7 63.0 66.9 90.5 33.4 84.1 72.3 76.6 93.0 91.7 125.1 15.9 66.0 151.0 120.4 93.4 75.8 62.5 125.9 II.2 118.9 77.6 64.8 96.3 77.4 102.2 74.3 88.6 109.8 84.1 91.0 92.2 143.7 73.9 97.8 66.5 108.5 78.1 119.1 73.9 95.9 80.2 45.1 80. Leaf NT TAS ACT Australia 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 56.8 122.8 106.6 73.4 65.5 66.4 44.7 54.2 51.9 140.5 118.2 59.4 48.9 103.0 46.6 74.0 80.1 84.6 65.4 74.1 70.8 96.3 84.2 48.0 53.0 91.9 99.6 93.2 134.7 65.2 79.0 72.3 67.1 58.0 68.6 93.3 67.
6 Median = 81 Frequency 10 8 6 4 2 0 140 130 120 110 100 90 80 70 60 50 40 More B. Leaf 16 14 12 Mean = 82 SE of mean = 3.7 Median = 77 Frequency 12 10 8 6 4 2 0 140 130 120 110 100 90 80 70 60 50 40 More C.15 FIGURE 3 HISTOGRAMS OF DISCOUNT FOR BULK BUYING OF MARIJUANA (100 × logarithmic ratios of ounce to gram prices) A.2 Median = 78 Frequency 10 8 6 4 2 0 140 130 120 110 100 90 80 70 60 50 40 More . Leaf and Heads 16 14 12 Mean = 80 SE of mean = 2. Heads 20 18 16 14 Mean = 80 SE of mean = 2.
Let p′ be the price of marijuana sold in the form of a packet of s size s. There are two ′ ′ versions of this relative price. In logarithmic terms.1) log p′ = α + β′ log s .1 .1) and (4.2) that these relative prices can be expressed as . We shall refer to p′ / s as the unit price. We previously measured the quantity discount available by buying in ounces rather than grams by the logarithmic ratio log ( p 28 / p1 ) . so we expect 0 < β′ < 1 .2) log ps = α + β log s . It follows from equation (4. write ps for the s unit price p′ / s . while p′ is in dollars per ounce. 28. which is a pure number. s = 1 for a gram packet and s = 28 for an ounce packet. this version of the price is comparable for s s = 1. s where β′ is the size elasticity of the price. To simplify the notation. while those of p 28 / p1 are grams per gram. so that the unit price falls for largersized purchases if β < 0 .16 4. it follows from equations (4. As p′ / s is the price per gram. which we shall call the discount elasticity. consider the price of ounce purchases in terms of the price of grams. Next. p′ / p1 and p 28 / p1 . It is to be noted that as the ′ quantity units differ. Consider the following 28 relationship between price and packet size: (4. As we have previously observed substantial quantity discounts for marijuana. the two values of p′ are not directly comparable as p1 is measured in s terms of dollars per gram. The units of the relative price p′ / p1 are 28 28 grams per ounce. the price increases less than proportionately to size.1) that (4. or when the size elasticity β′ < 1 . THE SIZE AND DISCOUNT ELASTICITIES It is convenient to introduce at this juncture a slightly different notation that will be used in the remainder of the paper. the percentage s change in the unit price resulting from a onepercent increase in packet size. and let β = β′ .
log 28 = β log 28 .17 p′ p 28 = β′ log 28. which involves a factor of 28. log 28 log β = p 28 p1 . Using this value.25 . and its relationship to . log 28 In the previous section we observed that the quantity discount was of the order of 80 percent.80 . the discount elasticity β normalises the discount by deflating it by log 28. β′ and β . log 28 3. ′ p1 p1 log It then follows that the size and discount elasticities. together with log 28 ≈ 3. so that the rate of increase of marijuana prices is only about threequarters of the proportionate increase in package size. it follows from the second member of equation (4. The upshot of this is that while the quantity discount is not comparable across products involving size differences other than ounces/grams. As revealed by equation (4. are related to the relative prices according to log (4. log ( p 28 / p1 ) ≈ −.4) ˆ β = In Section 6 we shall show that this way of estimating β has some attractions.3). SIZE AND THE DISTRIBUTION OF PRICES Rather than just two sizes of the product.3) β′ = p′ 28 ′ p1 .33 . now consider a larger number given by the set G. 5.80 ≈ ≈ .75 .33 (4. It is then possible to consider the nature of the distribution of prices. Note that equation (4. Recall that the quantity discount log ( p 28 / p1 ) is a pure number: Marijuana is approximately 80 percent cheaper if purchased in the form of ounces rather than grams. But this percentage has embodied in it the transition from grams to ounces. the discount elasticity β has no such problems.3) that an estimate of the discount elasticity is log p 28 p1 .4) implies an estimated size elasticity ˆ ˆ of β′ = β + 1 ≈ . that is.
2) and (5. This shows that the mean price is independent of mean size under the condition that there is no quantity discount.18 package size. p. The use of market shares as weights serves to give more weight to the more popular sizes. Π s = Σ w s ( log s − log S) . The mean of the prices can also be viewed as a stochastic price index with the following interpretation (Theil. is unity and β = 0 . Suppose we draw prices at random from this distribution such that each dollar of expenditure has an equal chance of being selected. The means in (5. the logarithms of which are: (5.2) .2) log P = α + β log S . β < 0 and the mean price falls as the mean size rises. which is the first member of equation (5. β′ . which is reasonable. A similar interpretation applies to the mean packet size log S .1) can be considered as weighted firstorder moments of the price and size distributions.2) that the two means are related according to (5. Consider the prices log ps . 136). It follows directly from equation (4. The corresponding secondorder moments are Π p = Σ w s ( log ps − log P ) . 1967.3) These measures are nonnegative. with ∑ s ∈ G w s = 1 . so that the expected value of the price is ∑ s∈G w s log ps . Then. It follows from equations (4. Let w s be the market share of the product when sold in the form of size s ∈ G . When there are quantity discounts.1). increase with the dispersion of the relevant distribution and can be referred to as the price and size variances. 2 2 s∈G s∈G (5. as then the size elasticity of prices. log S = s∈G ∑w s log s .1) log P = s∈G ∑w s log ps . the market share w s is the probability of drawing log ps . s ∈ G . as random variables drawn from a distribution of prices. We summarise the prices and sizes by their weighted geometric means.
8 × 3. there is a size premium and the “discount” elasticity is positive.2 and w 28 = . we use the marijuana data with two package sizes.3) and the results are given in Table 3 in the form of . for a given standard deviation of sizes.1) and the results are given in Table 2 for leaf and heads..log P = β ( log s .4) implies that the dispersion of prices is less than that of sizes. If we have two values of the size elasticity β′ = 1 ± k . is related to the corresponding size deviation. with β the factor of proportionality. viz. 2002a). we compute the index defined in the first member of equation (5. while that of heads is $468. β = k . for k > 0 . ounces and grams. Regarding the package size index. Guesstimates of the two market shares are 20 percent for grams and 80 percent for ounces (Clements.4 . so that w1 = . log ps − log P . this is a constant equal to log S = w1 log 1 + w 28 log 28 = . the price increases more than proportionately to size. log s − log S .2) with β = 0 . or (5. β = 0 and the price distribution is degenerate. the index of leaf prices is $388 per ounce.19 that the deviation of the price of the product of size s from its mean. as then each price takes the same value α . In words.67 . These indexes are expressed as exp ( log P ) . S = exp ( log S) = 14. result (5.8 .4) has an interesting symmetry property for quantity discounts and premia. Using the price data given in the Appendix. Note also that result (5. this. In the case when β′ = 1 + k .4) ∏ p = β ∏s . multiplying by the relevant market share w s and then summing over s ∈ G . we compute the variance of prices defined in equation (5. the standard deviation of prices is proportional to the standard deviation of sizes. then the values of the discount elasticity are β = ± k . follows from equation (4. As β is expected to be a fraction. log ps . we obtain the result Π p = β 2 Π s . As equation (5. so the units are dollars per ounce. the dispersion of prices when β = k is identical to that when β = − k . or. of course.4) involves the absolute value of β . Squaring both sides of this equation. The second last entries in the last column of each of the two panels of Table 2 show that for Australia as a whole in 1999. To illustrate the workings of the above concepts. in terms of grams. Only when the size elasticity is unity.33 = 2. Using exactly the same approach.log S) .
Let yst = log pst . it is useful to explore the nature of the leastsquares estimates.33 . We apply this equation at time t ( t = 1. the means (and medians) are of the order of . ECONOMETRIC ISSUES Equation (4. the absolute value of the discount elasticity. s = 1. T ) and add a disturbance term εst : (6. it can be seen from equation (5.… . about 88 percent fall in this range. If we measure size in terms of grams.3 for leaf and . As before with the first moment. [ ys1 . Before implementing this equation. About 74 percent of the standard deviations of the leaf prices fall in the range 2040 percent. and its size.2) is a relationship between the unit price of package size s. It follows from equation (5. where α is the intercept and β the discount elasticity. as well as for the two products combined (panel C). while for heads. 28 . the ratios for the two products are combined by weighting them according to their relative share in consumption of . the variance of size is a constant.25. 6.5 As can be seen. and equal to that the ratio of Πp Π s = 1.3) that this measure of dispersion is unit free. . ι be a column vector of T unit 5 As for Figure 3.1) log ps t = α + β log s + εst . Suppose we have price data on two package sizes. we can then write p 28 for the per gram price of an ounce purchase and p1 for the gram price of a gram purchase.4) to Πs equals β . ysT ]′ be a vector of T observations on the price of package size s .4). ps . which agrees with the previous estimate of the discount elasticity given in equation (4. Figure 4 gives histograms of these ratios for the two products in all years and all regions (panels A and B).20 standard deviations.….7 for heads. ounce and grams.
we can write equation (6.21 TABLE 2 INDEXES OF MARIJUANA PRICES (Dollars per ounce) Region Year NSW VIC QLD WA I. with ε s = [ εs1 . 28 and t = 1.. Leaf 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 490 557 449 417 498 407 435 395 423 366 444 551 501 414 457 442 447 443 318 418 361 435 282 272 239 222 234 428 398 454 416 486 343 275 230 393 253 344 363 344 315 283 293 309 437 447 270 427 371 391 394 394 396 394 392 332 332 355 334 298 353 328 346 354 355 339 387 436 245 225 206 209 241 401 392 313 305 449 372 394 297 454 318 455 423 495 492 415 444 448 377 374 402 413 418 388 407 388 406 SA NT TAS ACT Australia II. Then as log 1 = 0. T in vector form as 0 y1 ι = y 28 ι log 28 ι α ε1 + .. 0 be a vector of zeros. and ′ 28 ε = [ ε1 ε′ ]′ . Heads 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 680 680 488 558 638 631 640 663 576 610 616 715 634 540 396 426 459 464 466 453 438 499 527 539 460 431 415 388 454 555 581 343 470 680 572 447 493 464 411 379 355 325 294 442 514 295 414 545 516 530 477 464 407 464 463 379 379 492 414 386 420 352 427 391 369 401 586 540 525 419 418 444 465 432 420 371 462 522 441 545 438 617 520 639 497 510 556 528 646 596 491 481 511 506 517 540 504 468 526 elements.εsT ]′ ...… .1) for s = 1. β ε 28 .
9 36.0 13.2 21.5 26.1 34.3 47.9 47. Heads 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 25.2 16.2 37.9 52.8 35.7 30.9 27.8 26.4 33.2 37.4 6.4 21. Leaf 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 22.1 32.5 33.3 49.6 60.2 41.7 24.2 25.9 22.5 23.5 50.1 32.7 57.4 23.9 29.5 31.1 36.8 37.3 35.5 34.7 34.9 18.3 33.5 40.5 42.6 50.5 35.1 51.3 39.0 39.5 32.7 26.4 26.5 25.9 36.2 23.3 39.4 36.6 27.7 45.7 43.8 18.7 42.2 29.0 25.1 34.5 33.3 10. It follows that (6.3 29.1 23.1 26.5 24.5 32.7 10. y = Xγ + ε .1 27.9 33.4 37.5 14.9 23.3 33.2 32.9 27.2) 2 1 log 28 X′ X = T log 28 .3 43.2 29.7 53.2 19.9 33.2 38.8 34.7 39.0 58.2 37.5 19.4 29.5 30. X′ y = = 0 log 28 ι ′ y 28 log 28 Σ y 28.8 30.4 27.0 17.7 21.1 22.4 25.1 23.2 34.9 34.2 23.0 27. 1 log 28 ( X′ X ) −1 −1 log 28 1 = 2 .3 17.6 22.4 25.6 40.5 20.4 47.2 32. −1 T log 28 log 28 ι ′ y1 Σ Σ yst ι ′ s t .7 25.0 32.9 23.4 31.0 26.7 29.8 43.5 24.7 31.6 28.7 30.9 41.8 32.0 32.2 47.4 29.7 28.0 16.2 28.1 38.5 23.2 34.4 47.2 32.7 28.4 56.2 48.8 29.1 77.5 25.5 27.3 29.0 36.3 38.7 36.4 29.2 33.4 37.7 33.7 49.8 26.7 30.7 26.1 21.7 27.6 31.8 47.3 34.3 26.4 36. t t .4 33.9 22.4 63.4 24.3 13.0 30.7 30.2 32.7 43.7 43.6 18.9 33.5 8.8 39.5 29.2 26.7 37.5 19.0 II.8 36.1 38.22 TABLE 3 STANDARD DEVIATIONS OF MARIJUANA PRICES ( Π p × 100 ) Region Year NSW VIC QLD WA SA NT TAS ACT Australia I.0 52.3 22.0 29.2 27.4 42.1 36.7 17.7 23.8 38.4 28.3 38.2 28.7 30.4 or using an obvious notation.8 32.6 48.8 37.
25 0.15 0. Leaf 25 20 Frequency 15 10 5 0 Less 0.25 SE of mean = .23 FIGURE 4 HISTOGRAMS OF RATIOS OF STANDARD DEVIATION OF PRICES TO STANDARD DEVIATION OF SIZE A.20 0.30 0.24 Se of mean = .23 .40 More Mean = .30 0.25 0.20 0.15 0.35 0.35 0.09 Median = .40 More Mean = .30 0.23 C.35 0. Heads 30 25 Frequency 20 15 10 5 0 Less 0.15 0. Leaf and Heads 25 20 Frequency 15 10 5 0 Less 0.25 0.24 B.09 Median = .40 More Mean = .24 SE of mean = .10 Median = .20 0.
24 The LS estimator of the coefficient vector γ is ( X′X ) −1 X y .1). we have (6.3) is to note that as equation (6.Σ Σ yst + 2 Σ y 28. log 28 − log1 = log 28 .y 28 + 2 y 28 ) . log 28 where ys = (1/ T ) Σ t yst is the logarithmic mean price of package size s.1) will pass through the means for both grams ˆ ˆ ˆ and ounces.1)? Although either way would yield the same estimates of β′ and β. rather than the total price of package p′ = s × ps . in terms of the parameters of equation (6. As γ = [ α β]′ . the estimated intercept is the mean of gram prices. where σ2 is an estimate of the variance of εst . according s to equation (4.2) that ˆ var ( α ) = ˆ σ2 . y28 = α + β log 28 . ˆ y − y1 .4). we have for the two package sizes y1 = α . while the slope is the excess of the ounce price mean over the gram price mean. t s t t Σ Σ yst s t 1 = log 28 Σ y 28. The dependent variable in equation (6.3) ˆ α = y1 . It follows from the diagonal elements of the matrix on the far right of equation (6.1). The covariance matrix of the ˆ ˆ LS estimator is σ2 ( X′X ) . Why use this.3).Σ y 28.6 It is to be noted that the above expression for the estimate of the discount elasticity is exactly the same as that of equation (4. t t t log 28 s t ( ) = y1 1 ( y1 . it may appear preferable to use the unit price as the dependent variable because of units of 6 Another way to establish result (6.1) and using the above results.1) is the unit price. the estimator takes the form 1 log 28 1 2 T log 28 1 log 28 Σ Σ yst . In view of the special structure of model (6. the disturbance in −1 equation (6. and then estimate the size elasticity β′ = (1 + β ) . β = 28 log 28 In words. normalised by the difference in package size. t T 1 . . These two equations then yield result (6. T ˆ var β = () ˆ 2 σ2 T ( log 28 ) 2 .
1 (ounces) . with s = (1 28 ) × s for s = 1 28 (grams).. the units of p′ differ from s dollars per gram. But such an argument does not apply when we use the logarithms of the prices as then the factor converting one price to another becomes an additive constant rather than multiplicative. 1. and that the estimated slope would remain unchanged as this is an elasticity.. s The price data underlying the LS estimates given in equation (6. it can be enumeratored as follows: Unit of Measurement Grams Package size Size s Ounces Size s Price ps p1 Price ps p1 28 p1 Gram Ounce 1 28 1 28 p 28 1 When using ounces. Thus using a “ ˜ ” to denote prices and sizes expressed in terms of ounces. To enhance understanding of the workings of this notational scheme. to use dollars per ounce as the alternative unit of measurement. It would be equally acceptable. for s = 1 . These prices can be expressed in terms of ounces simply by multiplying by 28.1) becomes log ps t = α + β log s + εs t . the disturbances could be 28 heteroscedastic.. or ps = 28 × ps . t = 1. (6. rather than prices per gram? Intuition suggests that the estimated intercept would become the mean of prices of ouncesized packets. Recall that ps is the price per gram when marijuana is purchased in a package of size s . which is a dimensionless concept.25 measurement considerations. How do the estimates (6.3) are expressed in terms of dollars per gram.3) change if we use prices per ounce. however. so that var ( log ps ) = var ( log p′ ) . .1′) s = 1 28. for s = 28 . The units of ps are comparable across different package sizes as they are expressed in terms of dollars per gram. we have ps 28 = 28 × ps . We now briefly investigate this issue. One could then argue that as ′ the variance of p′ would be likely to be greater than var ( p1 ) . s = 1 (grams)..T . By contrast. equation (6. 28 (ounces) . to dollars per ounce.
∑ ∑ ys t y1 28 s t = − log 28 ∑ y1 28. t y1 t The LS estimates now thus take the form ∑∑ yst − ∑ y1 28. −1 log 28 ι′ ι′ X′y = − log 28 ι 0′ ( X′X ) −1 1 log 28 1 = 2 1 T log 28 log 28 . Thus7 α ε1 28 + β ε1 2 −1 log 28 X′X = T log 28 . 28 ) Thus the estimates of the parameters of equation (6. Note that the relationship between the ounce and gram notation is as follows: y = y + log 28 ι and .3′) ˆ α = y1 . log 28 (6.26 As log s = log 28 for s = 1 28 and log s = 0 for s = 1 .t T 1 ∑∑ y − 2∑ y T log28 1 st 1 28. 7 X = X + [ 0 − log 28 ι ] .1′) are ˆ y1 − y1 28 β= . where ι is a vector of 2T unit elements and 0 is a vector of 2T zero elements.t 1 ∑∑ y log28 s t t st 1 1 s t = 2 −log28 ∑ y1 28.t t log28 t log28 s t ( ) = y1 28 + y1 − y1 28 1 y + y − 2y 1 log28 ( 1 28 1 . proceeding as before. we have y1 28 ι − log 28 ι = 0 y1 ι or y = X γ + ε .
…. so that f ( pk ) = pk or f ( p k ) = log p k .. and the following is a simplified summary of some of his results.3) ˆ ˆ β = ( y 28 − y1 ) log 28 = β ..1) f ( pk ) = α + g ( zk ) β + εk . K . such as a personal computer. the identity or logarithmic? Suppose we use the logarithm of the price on the left of . ys = log 28 + y 28s . the two sets of prices are thus related according to y1 28 = log 28 + y1 . This establishes that in moving from grams to ounces as the unit of measurement (i) the estimated intercept becomes the logarithmic mean of the prices of the ouncesized packages. Equation (6.3′) and that It thus follows (6. Consider a crosssection application in which p1. with s = s 28 . such as the amount of memory of each of the K computers. A recent paper by Diewert (2003) considered some unresolved issues in hedonic regressions that are relevant to the previous discussion.. pK are the prices of K types of a certain product. package size. so that from equations y1 = log 28 + y28 and (6.1) can be thought of as a hedonic regression equation in which marijuana has one characteristic. zK are the corresponding values of a single characteristic of each type. and ε k is a disturbance term with a zero mean and a constant variance. f ( pk ) k = 1. HEDONIC REGRESSIONS The hedonic regression model relates the overall price of a product to its basic characteristics. The respective standard errors of α and β are identical to those of α and β . and (ii) the estimated size elasticity remains ˆ ˆ ˆ ˆ unchanged. Consider further the hedonic regression: (7. where is either the identity or logarithmic function. 7. α and β are coefficients to be estimated. The question to be discussed is.27 As ps = 28 × ps . what form should the functions f ( ) and g ( ) take.…. The seminal paper on this topic is Rosen (1974).. ˆ α = log 28 + y 28 . g ( z k ) is also either the identity of logarithmic function. In logarithmic terms. and “unbungles” a package of attributes by estimating the marginal cost/valuation of each characteristic in the form of a regression coefficient. and z1. ps = 28 × p 28s .
then β becomes the elasticity of the price with respect to z . Consequently.2b) εk = pk − α − β g ( z k ) ε′ = k pk . When we additionally use log z k on the right. which is more likely to have a constant variance. the disturbances in equation (7.2a) would be likely to take higher values for more expensive products. these disturbances are likely to be heteroscedastic. Which disturbance is more likely to have a constant variance? As k products with a high value of zk are likely to be more expensive. while more expensive products would still tend to have larger disturbances. g ( ) is logarithmic.1).28 model (7. if these errors are more or less proportional to the corresponding prices. and that the characteristic is now measured as . One advantage of doing this is that the coefficient β is then interpreted as the (approximate) percentage change in the price resulting from a oneunit increase in the characteristic. That is. When f ( p k ) = p k and f ( p k ) = log p k . With log p k on the left of (7. Suppose that the function f( ) is unspecified. and we wish to test the benchmark hypothesis that the price increases proportionately with the characteristic z . respectively.2b) as this involves the ratio of the price to its mean.1). This convenient property points to the use of logarithms on both sides of model (7.2a) (0. in other words. the price of a computer per unit of memory) is constant. that there are constant returns to scale so that the price per unit of the characteristic ( p k z k . this test can be implemented by setting g ( z k ) = log z k and testing β = 1 . Assume we have log p k on the left of (7. we have. (7. Now consider the stochastic properties of the disturbance ε k in equation (7. and vice versa.1). Next.1). and lower for cheaper ones.1) (7.1). This argument also favours the use of the logarithm of the price on the left of equation (7. consider the implications of ensuring that the hedonic regression model is invariant to a change in the units of measurement of the characteristic z . the exponential) in equation (7. exp {α + β g ( z k )} where ε′ = exp ( ε k ) .1) and the identity function for the characteristic. This would possibly be less of a problem with the logarithmic formulation (or its transform. then the variance of the ratio of the price to the conditional mean will be more or less constant.
5) slightly to accommodate our terminology and notation. the simple average is fair. he justifies weighting as follows: If product type k sold q k units. 43): It has already been observed that the purpose of any index number is to strike a ‘fair average’ of the price movements . relative to the second and third. Diewert refers to Greene (1993. This implies that the two sets of coefficients are related according to β∗ = β and α∗ = α − β∗ log c . so that α + β log z k = α∗ + β∗ log z∗ for all k values of z . where α∗ and β∗ are new coefficients. p. just because it treated all terms alike. for example. To justify this approach. Diewert quotes Fisher (1922. Everyone knows that pork is more important than coffee and wheat than quinine. p. The weighted approach has the advantage that we are able to assume more plausibly that the . Diewert (2003) emphasises the idea from indexnumber theory that the regression should be representative.29 z∗ = z c with c a positive constant. Paraphrasing Diewert (2003. The sense in which these two approaches are equivalent is that the LS estimators of the model with repeated observations are identical to those of the weighted model. At first a simple average seemed fair. then perhaps product type k should be times so that the regression is repeated in the hedonic regression q k representative of sales that actually occurred. Diewert argues that an equivalent way of repeating the observation on product type k times is to weight the single observation by qk q k . And. The hedonic model now takes the form f ( p k ) = α∗ + β∗ log z∗ . Note in particular that invariance requires that there be an intercept in the model. which raises the question of weighting. Some types of the product will typically be more economically important than others. Thus the quest for fairness led to the introduction of weighting. 27779) for a proof. to receive twice the weight in the hedonic regression. But it was early recognized that there are enormous differences in importance. If there are only three types of the product and the sales of the first are twice those of the second and third. While these issues usually involve questions about how to induce homoscedasticity in the disturbance term. pp. Invariance requires that k the prices predicted by the two models coincide.or movements of other groups of magnitudes. in the absence of any knowledge of the relative importance of the various commodities included in the average. it would then seem natural for the first product.
T in vector form as W1 y1 w1 = W28 y 28 w 28 where Ws = diag w s . 28 and t = 1.1). 1987) and and Selvanathan and Rao (1994).. Diewert (2003) has a preference for logarithms to be used on both sides of the hedonic model (7. Accordingly. We write this equation for s = 1. The reason is that quantity weights tend to under. with weights equal to the square roots of the value of sales or. the reciprocal of the square root of total sales. equivalently. To summarise. Let w st be the market share of marijuana sold in package size s ( s = 1. equivalent to weighting by the square roots of the market shares as these differ from sales by a factor proportionality. y s = [ ys1 . price × quantity. with w1. we have . where yst = log pst . We multiply both sides of equation (6.. The occurrence of the square roots of shares in regressions involving prices is familiar from the stochastic index number theory of Clements and Izan (1981. Writing the above as y = X γ + ε .. t = 1 that w1• = T − w 28• .. As the disturbances of the repeatedobservation approach are identical for a given type of product. If we let w s• = ∑ T=1 w st .. of course. We now analyse the impact of weighting on this equation.1) satisfies the first two of these three desiderata.. which drops out in the LS regression.1) by the square roots of the corresponding value of sales... + β W28 ε 28 ′ w s = w s1 . w sT . εsT ]′ . log 28 w 28 0 W1 ε1 α . Equation (6... they obviously cannot be independently distributed. value weights are even better. for an intercept to be included and for that model to be estimated by weighted LS. and ε s = [ εs1 .3) w st yst = α w st + β w st log s + w st εst .. 0 is a vector of zeros. t = 1 ..1) by the square root of this share to give (7. the value. ysT ]′ .30 disturbances are iid. Diewert favours weighting observations in model (7. This is. t + w 28.(over) represent expensive (cheap) products. 28 for grams and ounces) in year t . market shares.. it then follows from the constraint t w1t + w 28.... strikes a proper balance between the two dimensions of the product. Although the (square roots of) quantity weights are preferable to equal weights.
t = w 28• . ˆ y − y1 . t st In words. t y 28. t y 28. We write these as w ′ = w st w s• . 1 log 28 w1 ′ ′y = X 0′ log 28 w′ 28 w′ 28 log 28 1 = ( T − w 28• ) log 28 −1 . Thus st the estimates of the parameters of (7. β = 28 log 28 where ys = ∑ T=1 w ′ yst is the weighted mean of the (logarithmic) price of package size s . t t w 28• T − w 28• log 28 . t = W28 y 28 log 28 ∑ t w 28. t 1 = T − w 28• 1 − ∑ t w1t y1t − ∑ t w 28. t y 28. t w 28• are both normalised shares. t w 28• log 28 = 1 1 log 28 T − w 28• ∑t w1t y1t T − w 28• − ∑ t w1t y1t T − 1 ∑ t w 28. t y 28. the estimated intercept is the weighted mean of the gram prices. the terms w1t ( T − w 28• ) and w 28. T w 28• log 28 .3) are (7. t y 28. each with a unit sum. t y 28. t w 28• w1t ∑t y1t T − w 28• = w1t 1 ∑ w 28.4) ˆ α = y1 . while the slope . t + T ∑ t w 28. t log 28 ∑ t w 28. t The LS estimator for the coefficient vector of γ . thus takes the form T w 28• log 28 ∑ t w1t y1t + ∑ t w 28. t y 28. t y 28. As ∑ t w1t = T − w 28• and ∑ t w 28. t ∑ t w1t y1t + ∑ t w 28.31 T 1 w log 28 X′ X = w 28• log 28 28• . log 28 ( T − w 28• ) log 28 −1 1 −1 ( X′ X ) −1 X′ y . −1 ( X′ X ) −1 W1 y1 ∑ t w1t y1t + ∑ t w 28. t − ∑ t w 28. t y − ∑ y1t t 28. t y 28.
It should be noted that the weights in result (7. we presented two types of estimates of the discount elasticity for marijuana. (i) the preliminary estimate given in equation (4. if the weights are constant over time. in addition to the package size and time dimensions. We shall follow this approach.1) which relates the unit price of package size s at time t.3). while the means in the latter are unweighted.1) with timeseries data. not commodities. which is based on the centre of gravity of the discount available when purchasing in ounces rather than grams.4) are with respect to time. Second. the estimates of β are of the order of . and εst is a disturbance term. The usual approach to this problem in the hedonic framework is to use a dummy variable for each period. In both cases. Previously.1). both have exactly the same form. normalised by the difference in the package size. ∀t. there is no gain to be had by using these shares as weights when estimating equation (8. 8.4). Before proceeding. we provide a third set of estimates on the elasticity by estimating equation (8. given in Figure 4. Result (7. in view of the analysis in the previous section.4) then st coincides with (6. In this section. an adjustment needs to be made for overall inflation during the sample period.25. to the package size.4) is to be compared with (6. First. and the only difference is that the former involves weighted means of the price. pst . As can be seen. (8. which is known as the “adjacent year regression” (Girliches. it would seem sensible to also control for this aspect. FURTHER ESTIMATES OF THE DISCOUNT ELASTICITY FOR MARIJUANA We return to equation (6. ys = ys and (7. Accordingly. several items need to be discussed. as our database has a regional dimension to it. where α is the intercept and β the discount elasticity. If .3). and (ii) the estimates based on the ratios of standard deviations of prices to those of the package size.1) log pst = α + β log s + εst . w ′ = 1 T. Third. log 28 − log1 = log 28 . as our market shares for marijuana are constant over time. 1971).32 coefficient is the difference between the weighted means of the two prices.
and the product dummy indicates that on average leaf is about 26 percent cheaper than heads. twenty of which are independent.. s = 1... sixteen of wihich are We also experimented with the following more parsimonious way of dealing with inflation and regional effects r simultaneously. 2002a). the pricing equation to be estimated is then (8. although their prices fall faster than those of leaf..2). leaf and heads.33 we denote region r by the corresponding superscript.8 are the guesstimated market shares for grams and ounces (Clements. This difference in prices agrees with the information presented in Table 2. These regional and temporal aspects of marijuana prices in Australia have been previously identified (Clements. Additionally. The data for leaf and heads are combined in column 4 by adding a product dummy variable. In the Appendix we provide estimates of the discount elasticity β for each of the ten years individually. the discount elasticity is again of the same order of magnitude (. This approach yields point estimates of β identical to those reported in this section.. while that of leaf is $406. The interpretation of the coefficient is as the expected value of log ( p r st P r t ) for grams ( s = 1 ). For each of the two product. a 23 percent difference. This amounts to 10 × ( 2 + 1) = 30 estimates of β.8 regions. and the coefficient β continues to be interpreted as the discount elasticity. 8 which can be used as the new dependent α variable in the regression r r log ( ps t Ptr ) = α + β log s r + εs t ..8 To estimate equation (8. 28 package sizes and t = 1990.24). the estimated discount elasticity is .. indicating that leaf is cheaper in all these regions as compared to NSW. implying that leaf prices have declined over time. .2) r r log ps t = α + β log s rt + regional and time dummies + ε s t . we see that the results are similar for heads.1999 . we present twentyfour reginal estimates of β . Looking at column 3 of Table 4. Here. 28 w s log ps t where w1 = .01. r and ps t is the price of package size s in year t and region r .25 with a standard error of . from which it can be seen that on average over the ten years the price of heads at the national level is $526 per ounce. there are thus 8 × 2 × 10 = 160 observations.2 and w 28 = . 2002b). Column 2 of Table 4 gives the leastsquares estimates of equation (8. The relative price of marijuana is then r log ( ps t Ptr ) . The coefficients of the regional dummies are all negative. for each of the two products and for the two products combined.. All except one of the coefficients of the time dummies are negative. we use the data described in the Appendix for r = 1.2) for leaf and as can be seen. Define an index of marijuana prices for region r and year t as log Ptr = ∑ s =1.
066) .046) .005 (. while 1990 is the base for the time dummies.051) .263 (.046) .319 (.210 (.221 (.023 (.833 .077) .076 (.077) .206 (.069) .069) .059) .061 (. the leaf dummy variable takes the value one for leaf and zero otherwise.046) .077) .051) .135 (.069) .173 (.391 (.214 (.378 (.153 (.066) .046) .182 (. .066) .308 (.059) .059) .272 160 7.239 (.205 320 SEE No.818 .077) . In column 4.366 (.258 (.238 (.151 (.116 (.051) .069) . of obs.066) .424 (. so the estimate of its coefficient measures the average proportionate difference between leaf and heads prices.248 (.077) .051) .280 (.046) .153 (.066) .078 (.051) .051) .881 (.009) .059) .038 (.077) .140 (.069) .077) .113 (.059) .196 (.446 (.010) .073) .34 TABLE 4 MARIJUANA PRICING EQUATIONS log p = α + β log s rt + regional and time dummies r st (Standard errors in parentheses) Independent variable (1) Constant α Log s.385 (.186 160 7.042 (.066) .007) .088 (.128 (.051) .246 (.357 (.059) .069) .182 (.242 (.127 (.199 (.304 (.138 (.854 .066) .051) .239 (.051) .191 (. Notes: NSW is the base for the regional dummy variables.285 (.077) .066) .059) .069) .257 (.198 (.050) .066) . β Regional dummies VIC QLD WA SA NT TAS ACT Time dummies 1991 1992 1993 1994 1995 1996 1997 1998 1999 Leaf dummy R 2 Leaf (2) Heads (3) Leaf and heads (4) 6.046) .037 (.366 (.023) .062) .164 (.046) .114 (.077) .
242 SE of mean=.28 .23 Range .35 independent. Entire Set Frequency 20 18 16 14 12 10 8 6 4 2 0 . these histograms support the notion that the discount elasticity is of the order of . implies a . Independent Subset Frequency 12 10 8 6 4 2 0 . FIGURE 5 HISTOGRAMS OF DISCOUNT ELASTICITIES FOR MARIJUANA A. while panel B deals with the 20 + 16 = 36 independent estimates.24 M ean=.30 . equation (2.21 .006 In Section 2. While there is some dispersion.14) relates the size elasticity to the markup factor ( δ ) and the conversion factor in going from a larger package size to a smaller one ( φ ).25 and φ = 28 .log δ log φ . In terms of the present notation.28 .21 . Thus.242 SE of mean = . Figure 5 presents histograms of these additional estimates.30 . this equation implies that the discount elasticity is related to these two factors according to β = .26 .26 .19 .25.19 . a value of β = − . panel A deals with the entire set of 30 + 24 = 54 estimates.17 Mean = .17 B.004 .
mushrooms. kidney and other beans. Mills generously provided us with the basic price data for the seven product groups listed in column 1 of Table 5. For a total of 149 products.25.42 for baked beans. to .30 . Does this same rule apply to other markets? In this section. Brown and Silverman (1974) analyse the pricing of heroin in a number of US cities and relate the price per unit to package size. (ii) are mostly undifferentiated products. (ii) “Canned vegetables” refer to cans of green beans. from one store of each of the five major chains and one major franchise group.30). The results are contained in panel I of Table 5 and as can be seen. EVIDENCE FROM OTHER MARKETS Our investigations in the previous sections revealed that marijuana prices are subject to substantial quantity discounts.36 markup factor of δ = exp (. or about 130 percent in transforming ounces into grams.25 × log 28 ) = 2. peas and creamed corn. He collected prices of prepacked goods sold in two or more package sizes. beetroot. The 149 products were then aggregated into 29 product groups. These product groups were chosen on the basis that they (i) exclude those products for which Mills found quantity surcharges. the estimated discount elasticity ranges from . “discounted” or “special” prices are used.15 to . and all are significantly different from zero. purity and the month of purchase. and (iii) are relatively homogenous. we examine this issue with the prices of groceries and other illicit drugs. Using several approaches. In discussing the 9 There are two exceptions to this rule: (i) “Baked beans” refer to both baked beans in tomato sauce and spaghetti in tomato sauce. In panel II of this table the product dummies are suppressed and the only discount elasticity that changes appreciably is that for sugar (from . there were 423 distinct package sizes. Chap.12 for rice. 7) conducted a special survey of Sydney supermarkets in January 1995 to study quantity discounts. Mills (2002. This value seems not unreasonable. . we found that marijuana prices tend to obey the rule that the elasticity of the unit price with respect to package size is about .9 We use the groceries data to regress the unit price on package size and a set of product dummy variables to control for any withingroup heterogeneity. where available. 9.
098) .372 (.419 (.111 69 78 35 32 71 34 122 Continued on next page .036) .336 (.033) . Rice 6. Baked beans 2.046) .038) .047) .376 (.183 (.907 (.154 (.156) .098) .044) .309 (.032) .075 .004 (.305 (.156) .114 (.012) 4.298 (.964 (.018) .151 (.030) .144 (.716 (.885 .073 .118) .740 .066 .933 (.035) .025) .040) .047 (.156 (.019) .192 .018) .118 (.035) .156) .035) .095 (.095 (.262 (.080) .874 .052) 4.044) .114 (.034) . Cheese 3.795 .057 (. Flour 4.383 (.026 (.122 (.156) .405 (.441 (.020) .024) 4.114) .148 (.033) .246 (.717 .045) .279 (.228 (. Canned vegetables 1.047 (.050) .156) . Sugar 7.011 (.259 (.308 (.358 (.37 TABLE 5 GROCERIES PRICING EQUATIONS log psi = α + β log si + product dummies (Standard errors in parentheses) Product group Constant α (1) (2) Discount elasticity β (3) 2 (4) 3 (5) 4 (6) Coefficient of Product Dummies 5 (7) 6 (8) 7 (9) 8 (10) 9 (11) (12) (13) (14) R2 SEE No.124) .066 (.016) 4.030) .213 (. With Product Dummies 1.057) . Milk 5.023) .096 .909 .357 (.108 (.113 (. I.071 (.124) .038) .240 (.045) .046) .313 (.318 (.069 .027) .854 (.050) .157 (.034) .036) .033) . of obs.018 (.820 .046) .039) .
027) .383 (.38 TABLE 5 (continued) GROCERIES PRICING EQUATIONS log psi = α + β log s i + product dummies (Standard errors in parentheses) Product group Constant Discount elasticity α (1) (2) β (3) 2 (4) 3 (5) 4 (6) Coefficient of Product Dummies 5 (7) 6 (8) 7 (9) 8 (10) 9 (11) (12) (13) (14) R2 SEE No.140 (.020) 4.116 .466 .318 .018) 4.149 (. II.232 (.058) .048) 1.079) 4.138 .155) .132 .388 (.511 .884 (.768 (.219) .291 .831 (. Cheese 3.481 .296 (.540 .206 .037) .257 69 78 35 32 71 34 122 .015) . Rice 6. Flour 4. Baked beans 2.748 .832 (.116 . of obs. Milk 5.024) .040) 4.760 (.176 (. Canned vegetables .780 (.021) . Sugar 7.121) .088 . Without Product Dummies 1.030 (.
quantity discounts exist for licit goods as well. that is. the risk – are lower.75 (which implies a discount elasticity of . Although they estimate the size elasticities β′ . while that of the other six drugs is . Brown and Silverman (1974.25).39 possible reasons for a negative relationship between the unit price and package size. on the one hand. 210. Caulkins and Padman also provide some evidence that (the absolute value of) β tends to fall modestly . Later in the paper.23. which represent 75 percent of the total number of classes.as the package size increases.” This is an important qualification since not only are licit goods subject to quantity discounts. For the other weight classes. The results of Brown and Silverman for the discount elasticity are summarised in Table 6. the mean (weighted and unweighted. Brown and Silverman (1974. since the number of transactions – and. The mean of the four elasticities for marijuana is . p. and classes 11 and 12 on the other.or β′ rises .weight class 1. the elasticity is much more constant at around . As can be seen. p. This conclusion about the constancy of β′ when we omit the . which are presented in Table 7. presumably. A supplier may be willing to the charge less per gram when selling a larger quantity of heroin. Caulkins and Padman (1993) extended the approach of Brown and Silverman and applied it to the pricing of several illicit drugs. as measured by the discount elasticity β .17. which could be taken as saying the markup falls with size. these can be readily transformed into discount elasticiites via the relationship β = β′ − 1 . but as we have seen above the extent of these discounts. Although Caulkins and Padman imply that this is an instance in which there is a distinct upward trend in β′ . which is consistent with our results. which is a bit lower than most of the prior estimates. This result is illustrated in Figure 6 which plots the size elasticity β′ against package size for methamphetamine prices. seems to be more or less the same in both licit and illicit markets. 599) qualify the argument by adding in parentheses: “Risk is not the only factor here. 597) argue as follows: Because of both the changing nature of the risk involved and the value added to the product by the activities of middlemen. at least to a first approximation. the majority of this “trend” is accounted for by the behaviour at the two extremes of the weight range . there is reason to believe that the price at which a gram of heroin can be bought is affected by the quantity…of the purchase made. given in rows 42 and 43) of these elasticities is not too different to the previous values that we estimated for marijuana.
02) .31) . Boulder 6.25 (. Miami 21.04) .31) 23.03) .41 (. Tucson 41.15 (.97 (. Cleveland 9. Minneapolis .06) .15 (. New York/ Manhattan 28.23 (.04 (. San Francisco area 36.41 (.46 (.04) . (1994).34 (. Detroit 12.14 (.07) .21 (.16 (. Portland 34. New Orleans 30.04) . Seattle 38. Memphis 20. Philadelphia 31. Boston 5.27 (.05) . San Francisco 37. Tampa 40. 10 For related research.29 (.29 (. New York/ Bronx 26.40 (.04) .40 extremes would seem to be not inconsistent with the sampling variability of these estimates.C 42.03) .02) .06) . St Louis 39. Jacksonville 17.07) .04 (. Table 2).29 (.23 (.06) . Albuquerque 2. Denver 11. New York/ Long Island 25.05) .26) .22 (.22 (.10 TABLE 6 ESTIMATED DISCOUNT ELASTICITIES FOR HEROIN (Standard errors in parentheses) City Elasticity City Elasticity 1.22 (. Honolulu 14.01 (. Buffalo 7.80 (. Mean . Phoenix 32. Nashville 29. Dallas 10. Houston 15.43 (. Chicago 8. . Hartford 13.27 (.03) .05) .04) . New York/ Brooklyn 27.02) .08) .32 (.20 (.04) .17 (.16 (.26 Source: Derived from Brown and Silverman (1974.02) .19) 1.04) .09) .15) . Indianapolis 16. Baltimore 4.04) . see Rhodes et al.34 (. San Antonio 35.weighted . Pittsburgh 33.unweighted 43.28 (.17 (. Washington D.56 (.31 (.42 (.22 . Los Angeles 19.07) .04) .03) .03) . New York/ New Jersey 24.04) .22 (.02) . Note: The weights in the weighted mean in row 43 are proportional to the reciprocals of the standard errors. Kansas City 18. as indicated by the onestandard error band given in Figure 6.17) . Atlanta 3.11 (.03) .13) . Milwaukee 22. Mean .04) .28 (.22 (.03) .
10 (. Marijuana . Figure 3).Domestic .23 . 5. 8. while the broken lines give ± one standard error. 3. Tables 3 and 4).21 (.17 (.15 .24 .17 (. 4.01) .17 Source: Derived from Caulkins and Padman (1993. Source: Caulkins and Padman (1993.01) .16 (.Hashish .41 TABLE 7 ESTIMATED DISCOUNT ELASTICITIES FOR ILLICIT DRUGS (Standard errors in parentheses) Drug 1. Crack Methamphetamine Black Tar Heroin Power Cocain White Heroin Brown Heroin Mean of rows 27 Elasticity . FIGURE 6 SIZE ELASTICITIES FOR METHAMPHETAMINES Size elasticity β′ Note: The solid line plots the estimated elasticity against package size. .28 .02) .21 (.Sinsmilla .02) .Mean 2. 7.23 .Imported .02) . 6.01) .
the value for marijuana of about minus one quarter is not too different from averages found in other markets which pertain to both licit and illicit goods (groceries and drugs). these sorts of products seem to be subject to the following pricing rule: The price increases by 7. As it is convenient to standardise for the magnitude of the quantity difference in going from ounces to grams. so the size elasticity is about three quarters. As can be seen. Thus rather than the . as well as groceries and some other illicit drugs.5 percent when the product size increases by 10 percent. which is related to the size elasticity according to β = β′ . so that β′ < 1 and β < 0. Quantity discounts mean that the (total) price rises less than proportionally with size. Or alternatively: The unit price falls by 2.5 percent when the product size increases by 10 percent. economic forces transcend the law. While such a rule has much appeal in terms of its elegant simplicity. Although as an approximation the rule seems work satisfactorily with the averages reported in Table 8. we introduced the “size elasticity” β′ . the ratio of the percentage change in the (total) price to the corresponding change in the package (or lot) size. as indicated in Figure 7. CONCLUDING COMMENTS In many markets it is common for unit prices to decline as the quantity purchased rises. in this sense. and carried out an empirical investigation involving the prices of marijuana. This points in the direction of concluding that just because a good is illegal. For marijuana our estimates of the discount elasticity are of the order of minus one quarter. a phenomenon which can be considered to be part of the economics of packaging. Table 8 provides a summary of all the discount elasticities estimated or reviewed in the paper. This paper has reviewed the economic foundations of quantity discounts.1. Accordingly. there is not necessarily anything special about the manner in which it is priced. the percentage change in the unit price resulting from a onepercent change in the size.42 10. and the unit price falls. The unit cost of marijuana typically involves something like an 80percent discount when purchased in the form of ounces than grams. it is probably a bit of an exaggeration to claim that it has universal applicability. proposed new ways of measuring and analysing them. Another useful concept is the “discount elasticity” β. there is still considerable dispersion among the underlying elasticities.
30 0. 6. Row 2 is from panel B of Figure 5.23 .17 more Range . 5. Groceries pricing equation 4. Heroin 5. column 3 of Table 5. Row 4 is from the last entry of Table 6.25 as having the status of the centre of gravity of this elasticity. 2.23 . at least for the products considered in this paper. Other illicit drugs . the weighted mean. Mean ratio of standard deviation of marijuana prices to that of size 2.Caulkins and Padman 6. Marijuana .26 . Marijuana pricing equation 3.24 .24 . Table 8 SUMMARY OF DISCOUNT ELASTICITIES Source 1. 3.26 0.19 0. 4.28 0. it would seem more reasonable to regard the value of . Row 3 is the average of the entries in panel I.17 FIGURE 7 HISTOGRAM OF ALL DISCOUNT ELASTICTIES Frequency 35 Mean=.21 0. Row 5 is from the fifth entry of the last column of Table 7. Row 6 is from row 8 of Table 7.Caulkins and Padman Sources: 1. Elasticity . Row 1 is from panel C of Figure 4 (with the sign changed).24 0.24 30 25 20 15 10 5 0 0.43 discount elasticity being in the class of a “natural constant”.
in turn. based on the remaining observations. In general.44 APPENDIX The Marijuana Data11 The data on Australian marijuana prices were generously supplied by Mark Halzell. While the discounts display considerable variability over time in some regions. these discounts are plotted against time in Figures A1 and A2. we only focus on the prices of “leaf” and “heads”. Plotting the data revealed several outliers which probably reflect some of the abovementioned recording problems. and (iii) annualising the data by averaging the quarterly or semiannual observations. The prices are usually recorded in the form of ranges and the basic data are listed in Clements and Daryal (2001). These observations are omitted and replaced with the relevant means. For the two products. The different types of marijuana identified separately are leaf. The data after consolidation and editing. draws on Clements and Daryal (2001). Figure 5 of the text is a histogram of these estimated discount elasticities. Further Results Table 4 presents estimates of equation (8. of the Australian Bureau of Criminal Intelligence (ABCI). Tables A3 and A4 present estimates of the analogous equation on a (i) yearbyyear basis and (ii) regionbyregion basis. 11 . as these products are the most popular. Table 1 of the text gives the discounts available if marijuana is purchased in the form of ounces rather than grams. heads. The first part of this section is from Clements (2002b) which. skunk. Observations are treated as outliers if they are either less than onehalf of the mean for the corresponding state. However. The data are “consolidated” by: (i) Using the midpoint of each price range. hash resin and hash oil. most of this “washes out” at the national level and the Australian discounts are fairly stable. purchased in the form of grams and ounces. These prices were collected by law enforcement agencies in the various states and territories during undercover buys.2) for all regions and all years. hydroponics. for each state and territory are given in Table A1 and A2 for leaf and heads. The data are described by ABCI (1996) who discuss some difficulties with them regarding different recording practices used by the various agencies and missing observations. The prices for Australia as a whole (given in the last column of the two tables) are populationweighted means of the regional prices. the eight regions and Australia as whole. (ii) converting all gram prices to ounces by multiplying by 28. for each state and territory. the data are quarterly and refer to the period 19901999. or greater than twice the mean.
400 1.050 1.400 1.060 583 998 1.155 1060 735 770 700 711 698 700 793 490 735 636 697 700 700 630 683 648 560 665 560 630 700 648 802 770 700 653 700 700 753 653 467 556 675 700 700 560 630 630 630 630 630 653 630 639 700 700 700 665 665 735 788 718 683 700 705 910 1.085 1.097 1.45 TABLE A1 MARIJUANA PRICES: LEAF (Dollars per ounce) Region Year NSW VIC QLD WA SA NT TAS ACT Australia Purchased in the form of a gram 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 770 1.050 700 613 443 560 508 525 467 642 642 630 642 630 595 753 753 700 613 723 700 674 748 852 797 645 780 797 950 843 798 817 803 Purchased in the form of an ounce 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 438 475 362 383 419 319 325 288 333 275 362 513 450 363 409 394 400 383 285 363 313 387 225 215 188 168 181 400 350 431 375 444 298 210 170 340 200 288 308 283 263 250 250 256 388 400 225 388 325 347 350 350 350 350 347 275 275 300 281 244 294 263 288 300 300 282 313 350 188 175 170 163 200 375 375 262 257 413 325 350 250 400 256 408 386 450 450 369 390 381 313 326 341 350 340 320 344 322 342 .
050 1.138 910 840 840 840 1.400 1.400 1.033 1.120 665 770 793 840 858 840 630 869 1.400 700 1.176 1.400 910 858 1.167 1.400 793 840 1006 925 1.120 1.036 700 700 700 700 770 793 840 863 823 840 773 910 1.120 962 770 840 840 749 704 700 630 560 788 1.171 1.155 963 700 723 630 909 840 840 770 747 980 1.120 1.103 834 993 974 946 977 889 842 989 Purchased in the form of an ounce 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 600 600 375 500 550 538 550 550 488 513 526 650 550 450 348 367 400 400 400 388 400 435 413 425 388 363 328 320 398 538 550 300 402 600 502 390 431 400 354 325 300 275 250 383 400 200 363 450 425 438 406 400 340 400 382 325 325 450 363 325 358 283 358 325 300 341 525 450 425 344 363 350 388 383 367 325 392 463 375 500 383 550 438 525 442 450 479 461 558 504 401 419 433 430 445 466 437 404 449 .46 TABLE A2 MARIJUANA PRICES: HEADS (Dollars per ounce) Region Year NSW VIC QLD WA SA NT TAS ACT Australia Purchased in the form of a grams 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Mean 1.160 1.120 1224 1.190 1.120 1.225 927 735 1.155 1.400 1.400 863 1.120 1.120 1.173 1.068 843 771 630 723 589 919 1.
47 FIGURE A1 DISCOUNT FOR BULK BUYING: LEAF (100 × logarithmic ratios of ounce to gram prices) 160 110 60 10 AUSTRALIA 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 160 110 60 10 NSW 160 110 60 10 VIC 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 160 110 60 10 QLD 160 110 60 10 WA 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 16 0 SA 160 110 60 10 19 9 0 19 9 1 19 9 2 19 9 3 19 94 19 9 5 19 9 6 19 9 7 19 9 8 19 99 NT 110 6 0 10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 16 0 110 TA S 160 110 ACT 6 0 10 19 9 0 19 9 1 19 9 2 19 9 3 19 9 4 19 9 5 19 9 6 19 9 7 19 9 8 19 9 9 60 10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 .
48 FIGURE A2 DISCOUNT FOR BULK BUYING: HEADS (100 × logarithmic ratios of ounce to gram prices) 200 150 100 50 0 AUSTRALIA 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200 150 100 50 0 NSW 200 150 100 50 0 VIC 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200 150 100 50 0 QLD 200 150 100 50 0 WA 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200 150 100 50 0 SA 200 150 100 50 0 NT 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 200 150 100 50 0 TAS 200 150 100 50 0 ACT 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 .
728 (.220) .899 .949 (.666 (.254 (.258) .174) 6.084 (.150) 6.187) .233) .318 (.164 (.530 (.220) .164) .164 .130 (.233 .334 (.106 (.153 (.261 (.362 (.750 (.225) .233 (.140) 6.413 (.916 .955 .265) .230 (.225) .275 (.187) .036) .187 .239) .302 (.347 (.164) .264 (. of obs.157 (.885 .473 (.182 (.194 (.164) .239) .089 (.200) .239) .280 (.303) .303) .335 (.200) . Leaf 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 6.303 .857 (.303) .239 (.187) .232 (.202 (.200) .187) .220) . I.108 (.303) .597 (.225) .210 (.258) .233) .265) .225) .132 (.241 (.258) .182 (.237 (.257 (.803 (.033) .599 (.045) .239) .164) .333 (.368 (.476 (.258 .218 (.225) .203 (.781 .164) .034) .365 (.025) .039) .239 .165) 6.225 16 16 16 16 16 16 16 16 16 16 Continued on next page .239) .164) .045 (.393 (.289 (.207 (.225) .942 .258) .187) .220 .179) 6.588 (.765 (.258) .720 (.164) .030) .225) .265) .879 .265) .381 (.169) .367 (.303) .210 (.49 TABLE A3 MARIJUANA PRICE EQUATIONS BY YEAR r log ps = α + β log s r + regional and product dummies (Standard errors in parentheses) Year Constant α (1) (2) Discount elasticity β (3) (4) R2 Leaf dummy VIC (5) QLD (6) WA (7) Regional dummy SA (8) NT (9) TAS (10) ACT (11) (12) (13) (14) SEE No.535 (.258) .265 .200 .303) .427 (.357 (.056 (.900 (.911 .028) .379 (.636 (.883 .234 (.233) .200) .265) .277 (.227) 6.265) .268 (.570 (.239) .220) .293 (.218 (.303) .557 (.358 (.234 (.200) .236 (.187) .004 (.220) .301 (.016 (.436 (.233) .123) 6.187) .011 (.035) .233) .800 (.239) .040) .258) .220) .220) .669 (.863 .198) 6.887 (.200) .257 (.193) 7.206 (.058 (.289 (.233) .274 (.200) .265) .266 (.233) .
634 (.184 (.114) .100) .351 (.004 (.238 (.116 .086) 7.234) 6.50 TABLE A3 (continued) MARIJUANA PRICE EQUATIONS BY YEAR r log ps = α + β log s r + regional and product dummies (Standard errors in parentheses) Year Constant α (1) (2) Discount elasticity β (3) (4) R2 Leaf dummy VIC (5) QLD (6) WA (7) Regional dummy SA (8) NT (9) TAS (10) ACT (11) (12) (13) (14) SEE No.017) .022) .432 (.379 (.917 .144 (.215) .415 (.132) .150 .015) .175) .215) .132) .457 (.255 (.112) 7.116) .361 (.020) .000 (.312) .278 (.150) .114) .964 .150) .312) .131) 6.049 (.862 (.215) .215) .114) .175) .150) .898 . of obs.100 .116) .116) .214) .456 (.161) 6.132) .312) .970 .214 .018) .982 (.032) . II.150) .101 (.161) 7.971 (.942 .265 (.542 (.108 (.225 (.466 (. Heads 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 7.230 (.312) .974 .100) .229 (.119) .116) .175) .285 (.114) .132 (.132 .207 (.318 (.047) .122 (.215) .020 (.245 (.151 (.215 .273 (.119) .116) .312) .371 (.017) .224 (.150) .214) .091 (.434 (.542 (.088 (.175) .132) .075 (.114) .132) .312 (.410 (.272 (.174 (.441 (.263 (.175 .407 (.122 (.159 (.215) .279 (.119 16 16 16 16 16 16 16 16 16 16 Continued on next page .163 (.252 (.861 .125 (.114) .132) .325 (.091 (.394 (.099) 7.116) .404 (.312 .032) .205 (.087) 7.119) .980 .100) .066 (.528 (.258 (.214) .214) .082 (.325 (.215) .298 (.119) .214) .089) .165 (.313 (.150) .312) .650 (.075) 7.155 (.962 .498 (.144 (.100) .008 (.171 (.088 (.175) .574 (.119) .560 (.114 .044 (.357 (.175) .061 (.750 (.214) .456 (.100) .100) .214) .185 (.119) .175) .363 (.026) .219 (.405 (.517 (.132) .198 (.119) .438 (.114) .896 .100) .150) .312) .116) .
161 (.116) .022) .345 (.538 (.158) .092) 7.934 (.116) .188 (.102 (.258 (.407 (.146) .017) .131) .256 (.233 (.073 (.140) .100 (.645 (.147) .022) .019) .187) .105) .140) .125) .393 (.113 (.146) .079) .286 (.446 (.358 (.229 (.146) .158) .094) .448 (.116) .248 (.105) .846 .140) .470 (.116) .248 (.140) .460 (.083 (.148) 7.099) .148 .307 (.333 (.158) .395 (.572 (.873 .147) .259 (.361 (.158) .582 (.083) 6.123 (.467 (.177 (.187) .231 (.070) .270 (.099 (.280 (.147) .032 (.131) .158) .320 (.927 .125) .140) .131) .187) .021) .146) .251 (.207 .509 (.930 (.116) .140) .140) .855 .052) .105) .323 (.278 (.125) .070) .335 (.216 (.411 (.439 (.147) .121 (.257 (.208 .329 (.363 (.090 (.330 (.467 (. The leaf dummy takes the value one for leaf and zero otherwise.251 (.111) 7.148 (.910 .322 (.841 .330 (.177 (.146) .146) .125) .894 .187) .117) 7.278 (.202 (.264 (.104) 7.113 (.244 (.131) .228 (.131) .111) 6.342 (.016) .109 (.147) .140) .894 (.207 (.224 .028) .066) . Leaf and Heads 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 7.125) .116) .443 (.891 .020) .239 (.235 (.187) .131) .128 (.144 (.063) .892 .325 (.104 (.511 (.226 (.158) .208 (.280 (.321 (.147) .208 (.187) .177 32 32 32 32 32 32 32 32 32 32 Notes: NSW is the base for the regional dummies.140) .074) .125) .105) .323 (.158) .024) .156 (.51 TABLE A3 (continued) MARIJUANA PRICE EQUATIONS BY YEAR r log ps = α + β log s r + regional and product dummies (Standard errors in parentheses) Year Constant α (1) (2) Discount elasticity β (3) (4) R2 Leaf dummy VIC (5) QLD (6) WA (7) Regional dummy SA (8) NT (9) TAS (10) ACT (11) (12) (13) (14) SEE No of obs III.228 (.125) 7.075 (.068 (.259 (.058) .364 (.105) .185 .174 (.140) .105) .187) .140) .140) .073) .146) .140) .147) .165 .905 .265 .353 (.198 .131) .178 (.116) .199 .448 (.105) .204 (.021) .125) . .339 (.417 (.116) 6.332 (.140) .
079) .149) .199) .079) .011) .173 (.000 (.158 (.158 (.065 (.085 (.199) .279 (.277) .143 (.127 (.079) .044) 6.264) .264) .149) .037) .090 (.008) .264) .059) .079) .264) .199) .745 (.544 (.059) .264) .497 (.199) .059) .309) .079) .147 (.178 (.280 (.059) .059) .058) 6.035) .010 (.089 (.199) .277) .309) .108 (.047 (.040 (. Leaf NSW VIC QLD WA SA NT TAS ACT 6.185 (.059) 6.196) 6.079) .130 (.515 (.253 (.079 .027) .149 (.264) .141 (.149) .086 (.277) .974 .309) .199) .199) .319 (.293 (.183 (. of obs.213 (.199) .199) .079) .079) .104 (.079) .053 (.197 (.104 (.109 (.083 (.173 (.309) .096 (.275 (.229) 6.264) .916 .827 .206 (.149) .277) .059) .079 .895 (.205) 6.079) .149) .243 (.020) .340 (.195 (.488 (.108 (.031 (.149) .123 (.309) .104 (.044 (.079) .386 (.079) .196 (.318 (.309) .150 (.079) .277) .126 (.015 (.030 (.203 (.111) .543 (.047 (.934 .277) .149 20 20 20 20 20 20 20 20 Continued next page .044 (.665 (.096 (.384 (.150 (.059) .036 (.993 .059 .404 (.277) .52 TABLE A4 MARIJUANA PRICE EQUATIONS BY REGION log pst = α + β log s t + time and product dummies (Standard errors in parentheses) Region Constant α (1) (2) Discount elasticity β (3) Leaf dummy 1991 (4) (5) 1992 (6) 1993 (7) 1994 (8) R2 Time Dummy 1995 (9) 1996 (10) 1997 (11) 1998 (12) 1999 (13) (14) (15) (16) SEE No.037 (.127 (.566 (.079) .149) .277) .309 .059) .042 (.149) .264 .309) .277 .264) .058 (.079) .148) 6.277) .569 (.079) .011) .015 (.079) .118 (.716 (.059) .199 .895 .023 (.309) .073 (.176 (.506 (.110 (. I.013 (.079) .898 .264) .974 .309) .112 (.186 (.263 (.149) .042) .186 (.
153) .055) .097) .084 (.014 (.114) .041) 7.265) .153 .265) .097 .055) .123 (.114) .035) .081 (.043 (.131) .347 (.055) .265) .247 (.097) .262) .241 (.678 (.114) .055) .055) .097) .021) .241 (.163 (.123 (.194) 7.055) .072) 7.114 20 20 20 20 20 20 20 20 Continued next page .131 .097) .582 (.097) 6.784 (.221 (.424 (.153) .894 .993 .107 (.027 (.941 .077 (.114) .153) .021 (.131) .403 (.055) .265) .081 (.111 (.441 (.024 (.262) .262 .131) .131) .000 (.055) .007) .165 (.068 (.152 (.097) .114) .103 (.255 (.154 (.163 (.262) .131) .114) .354 (.114) .015) .114) 7.255 (.347 (.578 (.013) .000 (.028 (.131) .289 (.370 (.957 .034 (.153) .541 (.251 (.262) .153) .105 (.381 (.114) .084) .055) .062 (.036 (.265) .294 (.262) .539 (.153 .018) .153) .076 (.131) .247 (.030 (.53 TABLE A4 (continued) MARIJUANA PRICE EQUATIONS BY REGION log pst = α + β log s t + time and product dummies (Standard errors in parentheses) Region Constant α (1) (2) Discount elasticity β (3) Leaf dummy 1991 (4) (5) 1992 (6) 1993 (7) 1994 (8) R2 Time Dummy 1995 (9) 1996 (10) 1997 (11) 1998 (12) 1999 (13) (14) (15) (16) SEE No.153) .206 (.265) .498 (.022 (.395 (.131) .959 . II.593 (.262) . of obs. Heads NSW VIC QLD WA SA NT TAS ACT 7.131) .153) .207 (.113) 6.973 .153 (.262) .291 (.309 (.779 (.048 (.153) .021) .265) .153) .055 (.058 (.153) .153) .267 (.318 (.221 (.309 (.005 (.153) .344 (.114 (.051 (.052 (.860 .153) .202 (.111 (.949 .298 (.036) .097) .952 (.055 .014 (.208 (.337 (.262) .248 (.317 (.097) .097) .265) .114) .097) .187 (.153) .153) .051 (.465 (.153) .265) .262) .383 (.196) 6.265 .153) .
142) .214 (.092 .089) .162) .158) 6.040) .090) .089) .118 (.040 (.182 (.162) .090) .069) 6.101 (.156 (.390 (.204) .142) .019) .161 (.044 (.146 (.064 (.063) .029 (.267 (.077 (. The leaf dummy takes the value of one for leaf and zero otherwise.174 (.047 (.204) .162) .008 (.478 (.090) .049 (.070) .083 (.162) .778 .147) .041 (.108 (.090) .066) .037 (.204) .065) .271 (.020) .089) .162) .147) .877 .266 (.125) 6.289 .055 (.204) .976 (.029) .142) .142) .895 .204) .257 (.272 (.234 (.299 (.430 (.924 .409 (.142) .056 (.254 (.200 .050 (.127 40 40 40 40 40 40 40 40 Note: 1990 is the base for the time dummies.089) .089) .925 (.796 (.090) .006 (.242 (.162) .029 (.142) .162) .090) .142) .090) .004 (.231 (.089) . .000 (.084 (.180 (.319 (.089) .098 (.065) .125 .061 (.142) .114) 6.128 (.065) .211 (.196 (.089) .195 (.142) .162) .440 (.331 (.208 .065) .111 (.886 .204) .142) .162) . (16) α (1) (2) 1996 (10) 1997 (11) 1998 (12) 1999 (13) (14) (15) III.027 (.969 (.147) .218 (.063) .047 (.142) .420 (.269 (.050) 7.201 .172 (.247 (.142) .065) .110) 6.344 (.147) .040) .090) .217 (.142) .137 (.079 (.130 (.142) .280 (.090) .269 (.027) .229 .54 TABLE A4 (continued) MARIJUANA PRICE EQUATIONS BY REGION log pst = α + β log s t + time and product dummies (Standard errors in parentheses) Region Constant Discount elasticity β (3) (4) R2 Leaf dummy 1991 (5) 1992 (6) 1993 (7) 1994 (8) Time Dummy 1995 (9) SEE No.147) .204) .142) .103 (.032 (.142) .971 .286 (.065) .204) .147) .012) .199 (.019) .019 (.180 (.110) 6.147) .032 (.072) .022) .147) .171 (.009) .414 (.886 (.204) .345 (.142) .089) .091) . of obs.335 (. Leaf and Heads NSW VIC QLD WA SA NT TAS ACT 7.920 .147) .094 (.211 (.629 (.065) .065) .115 (.863 .193 (.142) .264 (.237 (.065) .126 (.020 (.261 (.166 (.103 (.326 (.012) .
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