The law of one price suggests that, in a perfect market, the price of a good in one nation will be identical to the price in every other nation. • Why do you think the law of one price is or is not a useful way to conceptualize prices? • What is one example of a real-world product whose international prices violate the law of one price? Justify your position through a thoughtful discussion that draws upon the readings and lectures for this week. In addition, you should seek out a timely and relevant external information source, such as an article from a reputable news provider like The Wall Street Journal or The Financial Times.
In practice, the assumptions build around the law of one price does not mostly hold. For instance, if the trade of commodities involves trade barriers and the costs of transactions, the law may not work. The international price of petroleum may vary from country to country, violating the law of one price (Choi, Shachar, & Shin, 2019). Several factors make the application of this law unrealistic in the real world as they are significant in determining the prices of commodities.
When trading with physical goods, transportation costs must come in, leading to a price difference for commodities from different locations. In case the transportation cost difference does not affect the price of commodities between locations, it may be as a result of excess or shortage within a specific location or region.
Because of the existence of transaction costs, which vary across various geographical regions and markets, the prices of the same commodities vary between the different markets. In places where the costs of transactions like costs to negotiate, cost of finding the right trading contemporary, and the cost to enforce the contract, are higher, the commodity’s price is higher than in other places or markets with lower costs of transactions.
Legal restrictions to trade like capital control, tariffs, and even wages and restrictions of immigration can result in persistent differentials in the price instead of one price. For instance, if a country imposes a tax or tariff on rubber importation, the price of domestic rubber will increase than the world price.
Considering the ability of sellers and buyers to enter the market may be different in various markets, the concentration of the market, the ability of sellers and buyers for setting prices may be different (Cipriani, Fostel, & Houser, 2018). A trader enjoying greater market power because of economies of scale, in particular, may behave as a monopoly setter of price and price the commodities higher. This may result in varying prices for similar commodities in a different market.
The law of one price is an economic concept that dictates what the price of an identical asset or commodity will have the same price globally, regardless of location or geographical differences. However, this concept assumes that there will be a lack of friction between global markets, the price of any asset would remain unchanged. This would then not work in a useful way, as having markets be frictionless at this point in time would be quite difficult. It would be useful if the markets were frictionless. One example of a real-world product whose international prices violate the law of one price would be the big mac made by Mcdonalds. The big mac revolves around the purchasing power parity and it involves the two currencies and provides a test of the extent to which market exchange rates result in goods costing the same in different countries. Something that follows the law of prices relatively closely would be the price of gold, as it remains the same throughout all the countries.
The law of one price is not useful in my opinion because it needs a perfect market without differences in cost for it to be effective. The law of one price is achieved by eliminating price differences through arbitrage opportunities between markets. Unfortunately, that is not the case between countries and there are many things to consider when deciding on a price, including transaction costs, transportation costs, legal restrictions, and/or currency exchange rates which fluctuate.
An example of where the international price violates the law of one price can be seen with the PlayStation 4 in Argentina. I actually had to buy one here and send it to my brother in Argentina and it was still cheaper than me sending him the money. So, the PS4 pro 1tb is $500 with the bundle off of amazon, but if you go to Mercado libre which is like their amazon/eBay it costs 85900 pesos which comes out to $1226 USD. That is more than double the price here and it’s not even for the bundle. There is so much which goes into deciding price and importing/exporting, shipping, the demand in poorer countries, etc.
This should be obvious by now with this pandemic taking over almost every country in the world. But, one of the biggest impacts businesses have is not being able to produce and import from china. The article I found discusses how Apple had to delay phones and AirPods due to the pandemic. But it’s not just this virus that causes these financial impacts, ” The tsunami that hit Japan in 2011 and devastating floods in Thailand the same year disrupted production for many big firms.” So, between natural disasters, import tariffs, and pandemics, we can not expect an identical price worldwide of goods. We are subject to the realities and changes in this world which dictate how much something will cost after expenses.
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