Question

Consider the following television: A 65" Vizio LED SmartCast Smart TV sold at Walmart for $468. Using the law of one price, what would you expect to pay for this TV if you were purchasing it in China, Japan, Canada, and Germany? How did you come up with your answers?

Answer 1

The Law of One Price (LOOP) says that the price of a commodity, when denominated in the same currency, will become equal across markets (e.g. across national borders). The proposition is based on the observation that a price differential opens up opportunities for arbitrage which will beexploited by self-interest pursuing economic agents to make a profit.

Suppose the TV is priced at $600 in China. Now, private entities can buy the TV for cheap in the USA and sell it for over $100 profit per unit in China while still charging less than the company. Thus nobody would buy from the company anymore, and the official price would likely be marked down by the company (if China is a sufficiently important market for the company/product).

On the other hand, other importers get a whiff of the sweet profits to be made and they join the race to import for cheap and sell at a profit. These importers undercut each other in price to try and capture the largest market share, essentially reducing the profit made by each producer. Eventually, competition is so stiff that each individual importer can charge hardly any more than the cost of purchasing it at the official price.

The consequence of this downward pressure is that price in China for the TV comes into equilibrium with price in the US.

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There is an obligatory caveat here. LOOP assumes that:

i) there are no barriers to trade - no tarriffs or government regulation inhibiting / prohibiting frictionless trade across national borders

ii) there are no transportation costs

Even if (i) were plausible - which it isn't, some nations plan and control more than others but all nations plan and control given the ever-present immediacy of economic stability - (ii) isn't plausible as of 2020.

So if it costs $25 to ship a TV to China, importers in China can't charge less than $468 + $25 = $493; otherwise they'd be turning a loss.

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In general,

a) following LOOP; and
b) assuming a competitive domestic market where importers compete and price undercut each other; and
c) no barriers to trade like tarriffs or regulations

Price of the TV in Country X
= {$468 + [Average per-unit cost of shipping one TV to Country X] }