# Law of One Price Explained: Definition, Examples & Key Assumptions

![Law of One Price: The theory that the price of an identical good or asset should be the same in different markets.](https://www.investopedia.com/thmb/3JAUp1Bvy4rL0XDlUYP7UU8HINk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Law-one-price_final-9b3420f1ce244e759a0c4538528f5e8a.png)

*— Investopedia / Michela Buttignol*

> **Definition**
>
> The law of one price is an economic principle stating that identical assets or commodities should have the same price globally when accounting for factors like transaction costs and market conditions.

## What Is the Law of One Price?

The law of one price is an economic theory that says identical goods should sell for the same price in different markets when certain ideal conditions are met. These conditions include no transaction or transportation costs, uniform [exchange rates](https://www.investopedia.com/terms/e/exchangerate.asp), and no market manipulation. If prices differ, traders can use [arbitrage](https://www.investopedia.com/terms/a/arbitrage.asp) (buying in the cheaper market and selling in the more expensive one) to profit until prices align.

This concept also underpins purchasing power parity, which compares currency values across countries. While the theory works in frictionless markets, real-world costs and restrictions often lead to price differences.

### Key Takeaways

*   The law of one price suggests identical assets should have the same price globally, given no market frictions.
*   Arbitrage helps eliminate price differences between markets, aligning prices through market equilibrium.
*   Despite its theoretical appeal, real-world factors like transaction costs and trade barriers often prevent the law of one price.
*   The law of one price underpins purchasing power parity, ensuring currency values reflect equal purchasing power across countries.
*   Market structure, legal restrictions, and transportation costs are common exceptions to the law of one price.  
    

## How the Law of One Price Impacts Global Markets

The law of one price is the foundation of [purchasing power parity](https://www.investopedia.com/terms/p/purchasingpower.asp). Purchasing power parity states that the value of two currencies is equal when a basket of identical goods is priced the same in both countries. It ensures that buyers have the same purchasing power across global markets.

In reality, purchasing power parity is difficult to achieve, due to various costs in trading and the inability to access markets for some individuals.

The formula for purchasing power parity is useful in that it can be applied to compare prices across markets that trade in different currencies. As exchange rates can shift frequently, the formula can be recalculated on a regular basis to identify mispricings across various international markets.

## Real-World Application: Arbitrage and Price Parity

If the price of any economic good or security is inconsistent in two different free markets after considering the effects of currency exchange rates, then to earn a profit, an [arbitrageur](https://www.investopedia.com/terms/a/arbitrageur.asp) will purchase the asset in the cheaper market and sell it in the market where prices are higher. When the law of one price holds, arbitrage profits such as these will persist until the price converges across markets.

For instance, if a security costs $10 in Market A and $20 in Market B, investors can buy it in Market A and sell it in Market B for a $10 profit without real risk.

When securities move from Market A to Market B, prices should change based on [supply and demand](https://www.investopedia.com/terms/l/law-of-supply-demand.asp), assuming other factors remain constant. Increased demand for these securities in Market A, where it is relatively cheaper, should lead to an increase in its price there.

Conversely, increased supply in Market B, where the security is being sold for a profit by the arbitrageur, should lead to a decrease in its price there. Over time, this would lead to a balancing of the price of the security in the two markets, returning it to the state suggested by the law of one price.

### The Big Mac Index: Measuring Trade Barriers

The Big Mac index is an informal measure of the significance of trade barriers and other geographic frictions in establishing the costs of similar goods, based on the market cost of McDonald's signature burger. Although a Big Mac is nearly identical in each geography, variations in labor costs, agricultural prices, and local regulations mean that the sandwich may cost as much as $8.17 or as little as $2.39.

## Why the Law of One Price Faces Challenges

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. 

### Transportation Costs

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. 

### Transaction Costs

Because [transaction costs](https://www.investopedia.com/terms/t/transactioncosts.asp) 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 Restrictions

Legal barriers to trade, such as [tariffs](https://www.investopedia.com/terms/i/import-duty.asp), [capital controls](https://www.investopedia.com/terms/c/capital_conrol.asp), 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. For example, if a country imposes a tariff on the importation of rubber, then domestic rubber prices will tend to be higher than the world price. 

### Market Structure

The number of buyers and sellers, and their ability to enter the market, can differ, affecting [market concentration](https://www.investopedia.com/terms/c/concentrationratio.asp) and pricing power.

A seller with strong market power from [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp) might set monopoly prices and charge more. This can lead to different prices for the same good in different markets even for otherwise easily transportable goods.

## What Are the Assumptions of the Law of One Price?

The law of one price assumes that there are no transaction costs or trade barriers between different markets, and that market actors are free to compete against one another. Given these conditions, the prices of most commodities should equalize between different markets, as consumers seek out the most affordable versions of each good.

## Why Is the Law of One Price Important?

The law of one price is the basis of establishing [purchasing power parity](https://www.investopedia.com/updates/purchasing-power-parity-ppp/), the principle that if a good should have the same price in different countries when you factor in currency exchange rates. If these prices are significantly different, that may be a sign that one currency is under- or overvalued.

## What Does the Law of One Price Mean in Finance?

In financial markets, the law of one price states that two equivalent securities should have the same value, even if they were created under different circumstances. In other words, a synthetic security should have the same market price as a physical security with the same payoffs. If this were not the case, an arbitrage opportunity would present itself that could be exploited by savvy traders.

## The Bottom Line

The law of one price states that identical goods should sell for the same price in different markets when there are no trade barriers, transaction costs, or currency differences. This principle relies on ideal conditions, such as frictionless markets and uniform exchange rates, and the absence of added costs, to hold true.

In reality, transportation fees, taxes, and local regulations often create price gaps that prevent perfect alignment. Arbitrage helps reduce these gaps by allowing traders to buy where prices are lower and sell when they're higher, but real-world hurdles can limit its effect.

The idea also supports purchasing power parity, as seen in tools like the Big Mac Index, which highlights how currency and market factors influence prices across countries. Understanding the law of one price and its limits can help investors and consumers better grasp how global markets work.  

> **Article Sources**
>
> 1.  Statista. "[Global Price of a Big Mac as of January 2024, by Country](https://www.statista.com/statistics/274326/big-mac-index-global-prices-for-a-big-mac/)."
>     
> 2.  NASDAQ.com. "[Law of One Price](https://www.nasdaq.com/glossary/l/law-of-one-price)."