Question

What is the Law of One Price all about? Does this law always exist in the market? Can you provide an example?

Answer 1

Law of One Price (LOOP) states that price of a good, service or asset must be identical in all countries or locations. LOOP is obtained when there are no arbitrage opportunities in the relevant markets. For example, if the price of a laptop is $1,000 in the US, then it will cost $1,000 in UK or in China too, adjusted for exchange rate.

In real life, LOOP does not hold. The concept of LOOP is based on the assumptions that transportation cost across locations is zero, information is costless, market demand are equal in both market and no other factor influences the exchange rate between countries. In real life, none of these assumptions hold. For example, the $1,000-priced laptop entails a transportation cost when it is exported to UK or China, therefore in order to maintain same proftability, the transport cost should be added to $1,000, making LOOP invalid.