The “Law of One Price”, as described by Isard (1977), appears to be empirically invalid, yet there are conflicting evidences such as gold prices as at 24 February 1995 (Rogoff, 1996), suggest that the Law seems to hold true. This essay shall evaluate the argument using both theories and empirical evidences related to Law of One Price and Purchasing power parity (hereafter PPP).
In essence, Law of One Price (hereafter LOOP) states that “the price of identical goods that are traded is the same in all geographical locations” (Persson, 2010, p. 221). To begin the investigation, preliminary observations can be made using market information with the Eurozone where the same currency is used within the currency union. Consequently, effect on differences in currencies “real purchasing value” is eliminated. In an ideal world where LOOP is applicable, if a car cost €10k in Paris, the same car should also be priced at €10k in Berlin. However, Wittendorff (2010) commented that despite the introduction of the single currency, substantial pricing differences are still observed amongst member states of the currency union. Indeed, this view is supported by an analysis on price differences of identical vehicles sold within the Eurozone across 3 years (Appendix 1) produced by the European Commission. The analysis suggests the above hypothesis does not hold good and pricing differences of up to 44.3% on the same car has been observed within the Eurozone.
In a nutshell, when there is a pricing difference on the same commodity in two different markets, prices should return to equilibrium. This mechanism is described as “if the same asset is selling for two different prices simultaneously, then arbitrageurs will step in, correct the situation and make ...
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The purchasing power parity implies the following relationship between the home (GB £) and local (US $) costs of debt:
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Conversion to modern worth: Lawrence H. Officer and Samuel H. Williamson. « Purchasing Power of Money in the United States from 1774 to 2010 » MeasuringWorth. 2011.
Adam Smith, David Ricardo and Thomas Malthus have all greatly influenced how people thought about modern economics, especially in areas relating to markets, in terms of the economy and whether certain things affected population rates. In this essay I will cover each of the three topic areas and how each economist interpreted these areas in order to explain why certain phenomena occur within British economics, most of which are still widely accepted today.
Throughout time, the human knowledge of economics has evolved and expanded. The discovery of this knowledge has been expedited, in many cases, due to a handful of brilliant minds. The work that these minds have contributed has helped to progress the human race, and helped further our understanding of economics. William Petty is one of those minds. Sir William Petty was an English economist, physician, and surveyor whose resume would impress even the most qualified. Petty began his life at the bottom of the barrel and worked up to the top, even becoming a knight along the way. William Petty’s influences were rooted in the teachings of Thomas Hobbes and Francis Bacon, and his views on natural law are clearly reflected in his work. Sir William
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Economists use two versions of Purchasing Power Parity: absolute PPP and relative PPP. Absolute PPP was described in the previous paragraph; it refers to the equalization of real price levels across countries. Relative PPP holds that the percentage change in exchange rates, over any period, equals the difference in the percentage price changes of different countries. It refers to the equalization of real price changes across countries. Absolute PPP implies relative PPP, but the...
The balance of payments, as from view of foreign contractors, increases the demand for the national currency’s exchange rate. If there is ...
Gustav Cassel (1920) provided the modern definition of PPP. According to Gustav, when measured in the same unit, the monies from different countries should have the same purchasing power and buy the same basket of goods. Otherwise, price differences will create international arbitrage which will bring adjustments in prices, exchange rates, or both, this international arbitrage will ultimately restore parity. Another way to interpret the parity condition is that the exchange rate between two currencies should equal the ratio of the countries’ price levels.
As with all markets and their respective economies, having equilibrium is one of the key factors of a successful system. Although most markets do not reach equilibrium, they attempt at getting close. There are numerous methods devised to reach equilibrium, whether they involve human intervention directly or a cumulative decision by all factors involved. These factors may be a seller's willingness to lower overall revenue, or a buyer's willingness to withhold some demand for a certain product. Of course, the basics of supply and demand retrospectively control the equilibrium in the market.
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The crucial importance and relevance of economics related disciplines to the modern world have led me to want to pursue the study of these social sciences at a higher level. My study of Economics has shown me the fundamental part it plays in our lives and I would like to approach it with an open mind - interested but not yet fully informed.
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