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Law of One Price Application: Comparing Your Money's Worth

Updated on March 10, 2013

An informative and insightful article on price variations among countries with brief introduction on the theory of "Law of One Price". This is a useful source of information for those wanting to understand price differences. Shoppers, travelers and even locals will find this interesting.

Shopping is one of the ultimate pleasures man can have. It is undeniable, that given the means to shop, people will definitely go for it. But as rational individuals, we always optimize our utility by purchasing at the least price possible. It's just logical: What's the best way to maximize happiness other than buying goods at the cheapest price possible?

However, the problem in reality is that we are not granted with full and perfect information; hence, we end up buying some goods at a relatively higher price, without knowing that the prices of the similar goods are cheaper somewhere else.

Inspired by the Big mac Index of "The Economist", this article will give an insightful comparison of prices among countries such as Philippines, Malaysia, Indonesia, Thailand, Singapore, Hong Kong, Japan, Taiwan and the United States to provide a general idea and information that consumers may find useful.

The Law of One Price

The Law of One Price is an economic theory stating that prices of goods and services should be equal (or converge into a single price) after taking into consideration the exchange rates.

Example : In US, one Big Mac costs about $4; hence, in Philippines it should cost about Php180.00. By factoring in the exchange rate of $1 to Php45.00, Big Mac in the Philippines would cost $4 which is supposedly equal to the cost in US. This shows how can your money's worth vary among countries.

However, this theory does not actualize itself in reality. Currently, Big Mac costs at about Php108.00 (or roughly $2.40) which is definitely not, in any way, equal to the $4 price of Big Mac in US (though there are other factors to account for the discrepancy).

Possible Factors for Price Discrepancy

  1. Quality - quality is considered a huge price-varying component of goods and services because, more often than not, higher quality comes with higher prices. This may explain why prices of Big Mac differ among countries (e.g. some burgers may be bigger than the others, some contains more meat, etc.)
  2. Cost of Doing Business s - this includes: taxes, cost of utilities and wages.
  3. Cost of Exportation/Importation - some goods incur higher freight charges; and hence, goods, even with same quality, will differ in prices due to the inclusion of such charges.
  4. Economic Structure - demand and supply are the two main concepts in Economics, and these are highly volatile. Different demographics entail different blend of demand and supply. This causes prices of goods to move and adapt to a level that will create an equilibrium between the two economic forces.

Categories in Table

  1. Food Category - this will proxy for the prices of food within the country represented by the price of Big Mac.
  2. Gadgets Category - this contains prices of gadgets commonly bought by consumers (e.g. iPhone, iPad, Blackberry and a DSLR)
  3. Clothing Category - this will proxy for the prices of clothing within the country represented by the price of a piece of clothing of Lacoste, a globally known brand.

Procedure

To give insight on various prices in 9 countries mentioned earlier, information was collected online regarding prices on food, gadgets and clothing. Note, however, that the data gathered may not be fully accurate and may not be the prices observed today.

Proceeding with the process, the data collected were all converted in US Dollar currency for comparability and then tabulated for ease of use and understanding.

The result is presented below.

Table 1: Comparative Price Table

Click on the photo to enlarge
Click on the photo to enlarge

Computation Procedure for Index

For a more comprehensive analysis of the prices presented in Table 1, the data were transformed into indexes that can be used to further analyze price variations.

How was it computed?

The country, United States, was selected to be the source of the base prices. Local prices in terms of dollars were then divided by the base price under a specific item. This would yield a quotient which served as the basis for the index.

Example: For Big Mac under Philippines, the local price in dollar is 2.51. This was divided by $4.07 which serves as our base price, This will result to a quotient equal to 0.62. Subsequently, this was done to all data collected.

How to use the index?

Simply put, the lower the value for the index is, the cheaper the product/good. Hence, for the Big Mac, it is cheapest to buy in Malaysia since the index is the lowest (0.56) among all other indexes.

Table 2: Price Index Table

Click on the photo to enlarge
Click on the photo to enlarge

Additional Remarks

The Law of One Price, practically, does not hold true in reality (which is given proof by the two tables). Hence, it is best for us to gain information on prices to take advantage by enabling us to purchase at the cheapest price possible.

Let's all be wise spenders!

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