The law of one price

The law of one price states that the same product should have the same price across countries. For example, if a T-shirt costs $10 in the U.S. and the exchange rate is 100 Japanese yen = 1 U.S. dollar, then the T-shirt should cost 10*100 = 1000 yen in Japan.

Why should the prices be the same? For example, if T-shirts are more expansive in Japan than in the U.S., international traders will start shipping more T-shirts to Japan and less to the U.S. Then, the prices in Japan would decline and in the U.S. they would increase. That would go on until the prices in the two countries become the same.

There are, of course, important reasons why prices could be different across countries:

The product is not exactly the same (not homogeneous, as economists would say). Then, the prices could be somewhat different.

High transport costs. It may be too expensive to ship products between countries. Then, even if their prices are different, no international trade will take place to reduce the difference.

Tariffs and other trade restrictions. For example, T-shirts may be more expensive in Japan because of a 10% tariff on textile imports. That price difference cannot be eliminated by international trade.

Different taxes. For example, a gallon of gasoline is much cheaper in the U.S. than in Germany because gasoline taxes are lower in the U.S. Again, international trade would not be able to eliminate that price difference.


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