Explain the Law of One Price. Give an Example

Question 3

Explain the Law of One Price. Give an example.

The law of one price states that in competitive markets free of transportation costs and trade barriers, identical goods sold in different countries must sell for the same price when expressed in terms of the same currency. img = (E$/£) × ( img ) for good i. E$/£ = img / img If, for example, the price of the same sweater was cheaper in London than in New York, U.S. importers and British exporters would have an incentive to buy sweaters in London and ship them to New York, pushing the London price up and the New York price down, until both were equal.