Many countries around the world engage in transnational trade with one another. In many cases, transnational trade requires that goods sold between two nations have the same price in comparison with the common currency. On the same note, some laws require nations to ensure that they sell their products at common prices so that they may all have the sane prices index and maintain adequate sales. However, studies have shown that most countries have varying prices that make it impossible for them to maintain the same prices index across national markets. As such, it is important to examine how purchasing power parity and the laws of one price vary between the same goods sold in China and America.
Some of the products that both Chinese and Americans produce include the Porsche Cayenne, which is a medium sized crossover luxury vehicle. In the US, the car sells at a$50,000 while in China, it has a price of $149,000 equivalent to 922,000 Yuan. This difference in prices of the same car occurs due to the purchasing power parity (PPP) in both nations. The purchasing power parity requires that the same brand of a product or basket of goods should equate to the same amount if converted into a common currency (Taylor, 2001) . Therefore, the fact that the same car equates to different prices in America and China states that the purchasing power parity does not hold for the same product in the two nations. Moreover, the PPP also relates to the law of one price, which is a theory that holds that the prices of commodities or goods should remain the same when people consider exchange rates between two nations. It is another method of explaining the PPP. Thus, according to the law of one price, the amount of money charged for the product should be the same when the exchange rate is considered .
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Market arbitrage refers to the act of buying the same product and selling it in different markets at different prices. This occurs due to arbitrage opportunities that allow clients to take advantage of price and values of any given product to either increase or decrease its prices. For example, market arbitrage opportunities play a role in ensuring that people in the US buy the Porsche Cayenne at $50,000 while the people in China buy the same brand at $149,000. When such arbitrage opportunities present themselves for clients in different markets, it is possible that the arbitrageur will always buy the product from the low-cost market and sell it to the clients in the high-cost market.
However, if the purchasing power parity does not hold, then arbitrage prices with continue to hold until the prices of the commodity converge across all its markets (Ardeni, 1989) . In such cases, the law of one price is in place to ensure that sellers do not take advantage of price disparities that exist between two markets. For example, if the price of commodity A in the first market is $20 while the same commodity is sold for $40 in market B, the investor will hurry to purchase the commodity in market A and sell it in market B, hence, making a profit without incurring any risks. As the investors continue to sell the products from market A in market B, the prices will continue to shift depending on demand but eventually level out to a common price and achieving the law of one price for the two markets.
Triangular arbitrage refers to the type of a discrepancy that occurs between three foreign currencies. It exists when the currency exchange rates between the three markets do not match up (Sarno & Taylor, 2002) . Studies also show that triangular arbitrage is rare and markets that use it rely on computers to automate the process. Covered interest arbitrage refers to the process of an investor in a given market deciding to use a forward currency contract to circumvent possible exchange rate risks. It happens when investors decide to use a favorable interest rate in the a high -yielding market through a forwarding currency but evading any possible interest rates in the market. Intermarket arbitrage refers to an opportunity in which an investor takes advantage of the price differences between two markets and buys products in the low selling market while selling them in the high-priced market with the aim of making profits.
Arbitrage in many markets takes the form of triangular arbitrage, also known as the three-point or foreign currency arbitrage. In this case, the arbitrage will relate to a foreign exchange where the investor uses triangular arbitrage, which allows them to use technology such as computers to prompt the differences in currencies between three nations. In this case, a client will aim to buy a product from the low price market and sell them in two of the high-priced markets with the aim of making profits. This move is an ethical method of making money, especially when relying on technology such as computers to effect differences in foreign currencies. This is because market rates should follow the laws of demand and supply, hence causing the discrepancies in currency strengths. As such, no one should use technology to cause any discrepancies in any market with the aim of making more profits in one or two markets. However, the existence of triangular arbitrages in foreign exchanges may be a form of investment especially if it occurs naturally.
References
Ardeni, P. G. (1989). Does the Law of One Price Really Hold for Commodity Prices? American Journal of Agricultural Economics, Volume 71, Issue 3 , 661–669.
Sarno, L., & Taylor, M. P. (2002). The Economics of exchange rate. Cambridge, UK: Cambridge University Press.
Taylor, A. M. (2001). Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price. Journal fo the Econmetric society. Volume 69, Issue 2 , 473–498.
