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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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    • yougotme profile image
      Author

      Renz Kristofer Cheng 4 years ago from Manila

      Thanks for the comment Ddraigcoch! Putting things in perspective can be best done by showing graphs, charts and etc. And I myself was amazed by the results. :)

    • Ddraigcoch profile image

      Emma 4 years ago from UK

      If you used this method on fuel you would solve a lot of debates... the amount of times I have seen the USA vs UK in whinging about fuel prices against cost of living etc.

    • yougotme profile image
      Author

      Renz Kristofer Cheng 4 years ago from Manila

      I was also fascinated the first time we studied this in one of our Economics class. And I thought that it will be great if this applies in reality. But, I guess, it's also cool that it does not, because we can take advantage of those price variations. :)

      Thanks for dropping by Doodlehead! :)

    • Doodlehead profile image

      Doodlehead 4 years ago from Northern California

      Interesting theory. This is a very clear explanation and the charts are very helpful. This was a new idea I was not familiar with.

    • yougotme profile image
      Author

      Renz Kristofer Cheng 4 years ago from Manila

      Thanks travel_man1971! It's really interesting how same goods/product are priced differently among countries. There are a lot of factors to be considered that contribute to the difference. Nevertheless, as consumers, we often just focus on the prices alone. :)

    • travel_man1971 profile image

      Ireno Alcala 4 years ago from Bicol, Philippines

      Congratulations, kabayan! You got me here!

      Well, price index is so useful for travelers, like me, (being an OFW) hence, it will always give positive hints on where (what country) to buy gadgets, clothing and the like.

      With your hub and other infos from other sites, interested people will always be updated with this subject.

    • ripplemaker profile image

      Michelle Simtoco 4 years ago from Cebu, Philippines

      Will the prices matter on the Hubnuggets? Certainly not. Here you go...this hub has been nominated on the Hubnuggets. Check it out and join okay? https://hubpages.com/community/Friday-Weekly-Round...

    • yougotme profile image
      Author

      Renz Kristofer Cheng 4 years ago from Manila

      I agree with that! Big Index is just an estimate to check the PPP. Thanks for the comment!

    • profile image

      ScIoN 4 years ago

      The Big Mac Index is used as a fast metric to compare purchasing power among countries. Of course, it's just an approximation, so we shouldn't expect it to include all kinds of factors. For sure it will be more complex than that. :)

      finance.scioncho.com

    • yougotme profile image
      Author

      Renz Kristofer Cheng 5 years ago from Manila

      Yes, that's actually one of the fundamental weaknesses of the Big Mac Index. There are indeed a lot of factors to should be considered. However, we can't deny its popular usage in the field of Economics.

      Thanks Dannie for the comment. :)

    • profile image

      Dannie Tan 5 years ago

      I personally not so agree with that Big Mac Index. There are so many other factors that affect the price just like what you mentioned in the article. We too compared the price of a meal at Manila's McDonald with Malaysia's, the price there is just so economic and can be said it is 50% cheaper than ours. But yet since the price is lower, the portion of meal is smaller compared with our McDonald. What we can order here is only Medium or Large size meals, we do not have small size meals here.

      So different countries have its own supply and demand and its just not fair to compare the same thing in different countries.

    • yougotme profile image
      Author

      Renz Kristofer Cheng 5 years ago from Manila

      Wow! Thanks for that Docmo! Actually, I've generalize local taxes and import duty (tax) by just saying "taxes". But, yeah, I should have specified it. And, you are right, market size and market penetration (or market structure in general) do contribute to the discrepancy.

      Thanks again Docmo!

    • Docmo profile image

      Mohan Kumar 5 years ago from UK

      Fascinating look at the economics of 'one price' . You've done a grand job in explaining, illustrating and unravelling the principles. I wonder apart from the reasons you mentioned for the discrepancy there may be others such as market size, market penetration, local taxes and import duty also. Thanks for sharing an insightful hub. Voted up!

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