Question

Suppose a bottle of french wine costs 500 euros when sold in Paris but the same wine costs 350 British pounds in London. If the LOOP holds what is the Pound-euro exchange rate?

Suppose the dollar-euro exchange rate is 1.10 and the wine costs $600 in Ohio. Does the LOOP hold between France and the US? Explain

Answer 1

The Law of one price states that the price of a commodity must same in all the countries.

So a bottle of French wine costs 500 euros in Paris and costs 350 British pounds in London. It implies that 1 Pound = 1.67 Euro.

Now, Dollar - Euro Exchange rate = 1.10, so one dollar is equal to 1.1 euro.

And we have, 1 Pound = 1.67 Euro.

So, one dollar is equal to 1.1 Euro, hence one euro is equal to 0.91 dollars. 1.67 Euro is equal to 1.52 dollar. Thus it implies that 1 pound = 1.52 dollars.

LOOP states that Dollar-Pound exchange rate must be 600/500 = 1.2 dollars per pound. Hence LOOP does not hold between France and US.