Law of One Price: Definition, Examples & Implications
The Law of One Price Explained
The Law of One Price (LOOP) states that identical goods should sell for the same price everywhere once exchange rates and transport costs are considered. With markets increasingly integrated, this principle underpins theories of purchasing power parity, arbitrage, and global asset pricing, making it a cornerstone concept for economists, traders, and multinational businesses. Understanding how and why the rule functions equips stakeholders to spot pricing anomalies and grasp the forces that equalize values across borders.
How the Principle Works
Put simply, if two coffee beans of equal quality trade in New York for $3 per pound and in London for £2 per pound, the exchange rate should adjust or traders will buy in the cheaper market and resell in the dearer one until the price differential disappears. This self-correcting action is known as arbitrage.
Conditions for Price Parity
For the Law of One Price to hold, four key conditions must be met: identical products, competitive and transparent markets, negligible transaction and transportation costs, and free mobility of capital. Any frictions—tariffs, quotas, brand differentiation, information asymmetry—can create persistent price gaps, explaining why the LOOP remains an ideal benchmark rather than a daily reality.
Real-World Examples
Global commodity exchanges illustrate the principle. A barrel of West Texas Intermediate crude quoted on NYMEX cannot deviate significantly from its ICE Futures Europe counterpart once freight and currency conversions are considered. Likewise, Bitcoin pricing on major exchanges converges within seconds. Whenever spreads exceed transaction costs, automated trading algorithms arbitrage the discrepancy, restoring price uniformity.
Why the Law Matters
For investors, recognizing LOOP violations can uncover risk-free profit opportunities or signal mispriced currencies. Portfolio managers rely on the principle when constructing global index funds and hedging foreign-exchange exposure. Firms engaged in cross-border sourcing monitor price parity to negotiate better contracts and manage supply chains. Ultimately, the Law of One Price reinforces market efficiency and promotes worldwide economic integration.