The Law of One Price (Essay Sample)
The Law of One Price states that equivalent investment opportunities trading in different competitive markets will have the same price. Yet, one can find examples where that rule seems to be violated. It is a well-known fact that Americans pay a much higher price for most prescription drugs than people in most other countries. Also, the price (when adjusted for exchange rates) for the same make and model of automobile varies greatly across different countries. Furthermore, the price of a barrel of crude oil varies between locations. For example, on October 12, 2012, the price for Brent crude oil produced in Europe was $114.21 and the price for West Texas Intermediate (WTI) crude oil produced in Texas was $91.86.
Do these three cases demonstrate that the Law of One Price is false? Why or why not?
The Law of One Price
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 ...
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