Applying the law of one price to a single product is too simplistic a method for estimating exchange rates.

Question

Quizplus · Accepted Answer

The law of one price assumes that the same product should have the same price in different countries once the exchange rate is taken into account. However, in reality, there are many factors that affect the price of a product in different markets, such as transportation costs, taxes, tariffs, and local demand and supply conditions. Therefore, applying the law of one price to a single product may not accurately reflect the exchange rate between two currencies. A more comprehensive approach, such as purchasing power parity or relative factor endowments, is needed to estimate exchange rates.

Applying the Law of One Price to a Single Product