Reference no: EM132899827

1. The law of one price creates the foundation for the concept of purchasing power parity. It is difficult to achieve purchasing power parity due to a number of external factors such as location, transportation, regulations, etc. I do not see the law of one price as a useful way to conceptualize prices due to the inherent friction between international markets or parties involved in a transaction more generally. The costs associated with a transaction vary greatly depending on the location of the transaction. Along with this, governmental restrictions play a role in discerning factors such as availability, taxation, and overall demand. Price manipulation as well as a country's inflation rate also plays a key role in disproving the law of one price.

Tobacco products are an example of a product whose price will vary depending a number of factors. Russia for example, levies a 33% sales tax on a pack of 20 cigarettes while Massachusetts imposes a 40% tax on the same pack of cigarettes. Without even looking at the price, government intervention disrupts the one-price concept with the use of taxation. This concept can be further disproven by discussing the different levels of tobacco taxation depending on the state in which a consumer makes the purchase. A country that is going through times of economic uncertainty may attempt to stimulate their economy and encourage borrowing by inflating the nations currency. This will lower the value of the currency and require a greater number of a given currency to purchase the same product. If international markets worked in unison highlighting areas where trade-offs are available and minimizing advantageous manipulation opportunities, the law of one price may hold true.

2. 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?

I think the law of one price is not a useful way to conceptualize prices because there is no competing prices to compare to. If a price of a good is the same all the time in every nation, then it operates in a frictionless market. There are no transaction costs, transportation costs or legal restrictions. There will also be no arbitrage opportunities because the law of one price is completely eliminates price differences. It also means that buyers have the same purchasing power throughout global markets since the same good has identical prices.

What is one example of a real-world product whose international prices violate the law of one price?

Gasoline is an example of a real-world product that violates the law of one price. There are differences in prices among countries where generally, richer countries have higher prices and poorer countries and countries that produces oils have lower prices. The prices are also affected due to different countries imposing different taxes. Since COVID-19 started, demand for gas has severely dropped resulting in lower gas prices with higher supply. With the law of one price, there would be no fluctuations or supply in demand but instead the same prices.

3. 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.