The Law of One Price

The Law of One Price
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The Law of One Price
The theory of purchasing power parity (PPP) is among the oldest and most important concepts in the economics world. The theory emerged in the beginning of the 20th century, and since then, economists and other experts in the field have observed the law and tried to associate the law with empirical evidence. Under the PPP, the aggregate price levels should be similar across the countries, once the price has been converted to common currency. Based on such, the theory has featured widely in economics literature to evaluate and predict trends in the exchange rates. Well, the theory of law of one price is somewhat a reduced version of, and an important part of the PPP theory. However, the law of one price does not focus on the aggregate price levels, but suggests that, taken on an individual level, the price of goods and services should be similar in spatially separated markets once the prices are converted to common currency (Taylor, 2004).
Although there is much support about the law of one price, there have been questions concerning the law because in some instances, the law appears violated. For example, Americans pay much higher prices for most prescription drugs, when compared to people in other countries. In this regard, there are many examples, where the law appears not to hold, even after meeting the conditions of the law. What could be the cause? A sizea...