Economic theory states that in a world of international trade and market competition, prices for the same good in one country should be the same in another country, all else equal. This "law of one price", also known as purchasing power parity (PPP), argues that any glaring mispricings between the same good in two locations would be quickly arbitraged away by people who could grab risk-free profits.
In the real world, the assumptions built into the law of one price frequently do not hold, and persistent differentials in prices for many kinds of goods and assets can be readily observed.
- The economic theory of purchasing power parity (PPP) predicts that the price of a particular good should remain the same no matter where in the world it is sold.
- In reality, however, PPP is often violated with some goods selling for more in one place than another, even after accounting for exchange rate differences.
- Here we look at several reasons why the same good may sell for several prices at the same time around the world.
Real-Word Price Differences
What if you could compare the prices of goods across the world and then buy the products where they are the cheapest? Pricerunner.com had exactly that idea and compared the prices of a number of electronic goods in 28 cities around the world. The products the site compared included blu-ray discs, smart phones, tablets, and other consumer electronics. According to research conducted by Pricerunner, if a person purchased all of the items that they track, it would cost $1,757 in Tokyo; $1,969 in New York City; $2,012 in Dubai, United Arab Emirates; $2,450 in Copenhagen; $2,441 in Vienna; $2,540 in Cape Town, South Africa; $2,965 in Reykjavik, Iceland; and $3,387 in Sao Paulo. In another survey, the site compared the prices of a MacBook Air, an iPad, and an iPhone.The three items combined were cheapest in Tokyo at $2,225, and most expensive in Sao Paulo at $4,160. The same items would cost $2,745 in New York.
It's not only electronics that vary in price across the globe. Cars vary in price, too. For example, a standard Jeep Grand Cherokee that sells for about $32,000 in the U.S. costs upwards of $90,000 in Brazil (when converted from BRL to USD). The cost of buying a gallon of gas is far less than a dollar in OPEC countries, while Americans typically pay about between $2.00-$3.00 per gallon of gas. Most Europeans have to pay double that. There are a number of factors that affect the prices of these products in different countries.
Taxes and Import Duties
One of the major factors that affects the prices of goods is the difference in taxes and import duties across countries. Brazil, for example, has an extremely high import duty, or tariff, of 60%, which makes imported goods such as cars and phones so much costlier there. Many products are cheaper in Japan thanks to lower import taxes and better wholesale prices.
Even local taxes make a big difference. If San Francisco has an 8.5% sales tax and London has 20% Value-Added Tax (VAT), this will significantly affect the prices paid by the consumers. When talking about exports and imports, there is a significant difference between the treatment of sales tax and VAT. When exporting a good, VAT is charged on the item, but sales tax is not. When importing a good, the importer pays sales tax on the full price of the item, but pays VAT only for the value added by the importer. If you are importing into a country that doesn't have VAT from a country that has VAT, the product will be double taxed. The exporting country adds VAT, while the importing country charges sales tax.
With respect to oil prices, the prices vary significantly because of subsidies in some countries and fuel taxes in other countries. This is the reason why gas is absurdly cheap in oil producing nations such as Venezuela and Saudi Arabia. In the U.S., the taxes vary from state to state.
Another important factor is that the prices of items like electronics and cars are not always determined based on the cost of producing them. A product may have a higher perceived value in one country compared to another country. A common brand may have a perceived high value in one country and could be sold as a premium brand there, enabling the company to charge a higher premium. Even the cost of doing business in a country can affect prices. Hiring employees and setting up stores will not cost the same in every country.
When dealing in commodities, or any physical good, the cost to transport them must be included, resulting in different prices when commodities from two different locations are examined.
If the difference in transportation costs does not account for the difference in commodity prices between regions, it can be a sign of a shortage or excess within a particular region. This applies to any good that must be physically transported from one geographic location to another rather than just transferred in title from one owner to another. It also applies to wages for any employment where the worker must be physically present at the worksite to perform the job.
Because transaction costs exist and can vary across different markets and geographic regions, prices for the same good can also vary between markets. Where transaction costs, such as the costs to find an appropriate trading counterparty or costs to negotiate and enforce a contract, are higher, the price for a good will tend to be higher there than in other markets with lower transaction costs.
Legal barriers such as capital controls, or in the case of wages, immigration restrictions, can lead to persistent price differentials rather than one price. These will have a similar effect to transportation and transaction costs, and might even be thought of as a type of transaction cost.
Because the number of buyers and sellers (and the ability of buyers and sellers to enter the market) can vary between markets, market concentration and ability of buyers and sellers to set prices can vary as well.
A seller who enjoys a high degree of market power due to natural economies of scale in a given market might act like a monopoly price setter and charge a higher price. This can lead to different prices for the same good in different markets even for otherwise easily transportable goods.
The Bottom Line
While these price differences may earn big bucks for companies and governments, the real loser is the consumer who has to bear the brunt of high taxes, expensive infrastructure and high prices for regular goods.