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What is the Law of One Price?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 02 December 2016
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The law of one price is a theory in economics that identical goods should be priced the same, after accounting for the exchange rate, in different countries as long as the market is efficient. When the prices differ and people take advantage of arbitrage opportunities, their actions push the prices to converge, balancing them out in the end. Radically differing prices are an indicator of market inefficiency or peculiar circumstances.

According to the law of one price, buyers will seek out the lowest price, while sellers look for the highest price, and because the two must meet in the middle, prices, especially on financial markets, should be similar. Stocks trading in one market should trade for a similar price in another market, for example. If people are aware of different prices in another market, they will gravitate towards the prices most favorable to their interests. This changes the supply or demand in a market, thus leading to an adjustment in price.

With commodities, the law of one price must also incorporate costs of transport. In this case, the price for a commodity in two different locations would be expected to differ on the basis of transport costs. If the price differs by more than this, it is a sign of an emerging market trend such as a shortage driving a price abnormally high, or a glut forcing prices down. People can take advantage of differing values to engage in arbitrage, trading reliant upon price disparities for a profit.

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This economic concept is closely tied in with purchasing power parity. In equal, efficient markets, people should be able to purchase goods at the same price, after accounting for exchange and inflation rates, anywhere in the world. A cup of coffee, for example, should cost the same no matter where someone consumes it. The fact that this is not often the case is not necessarily a violation of the law. Instead, it is a reflection of people acting on incomplete information, or of other disparities in a market. In a nation where demand for coffee is high or higher prices are tolerated, prices will rise, for instance.

People engaging in international trade must consider the law of one price when preparing to make deals and working with pricing in different countries. Exchange rates shift rapidly and on a regular basis, making it necessary to recompute prices and values regularly, and markets can also shift suddenly, creating price disparities and opportunities for people in positions to act on them.

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Markerrag
Post 1

I can't help but wonder how this analysis plays out when it comes to a habit of companies to price goods higher in one area than another. For example, some software packages are sold for a discount in developing nations because we lucky stiffs in the "first world" can better afford those products.

I have even seen cases where medicine is sold at or below cost in certain stores in an area in an attempt to run other pharmacies out of business.

I'd wager that such deviations in price are put in place to either establish monopolies or to simply gouge consumers in one market just because it can be done.

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