Transcription of LOOP: Law of One Price - Washington State University
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LOOP: Law of One Price020406080100120140 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Oil Price in $Oil Price in EuroLong Run Exchange RatesLaw of One Price (LOOP)LOOP states that if There is free trade (no tariffs, quotas, etc) Transportation costs are low relative to the value of the product (diamonds, oil, wheat, but not Big Macs) CompetitionThen identical products sold in different locations will sell for the same Price (when expressed in a common currency)Law of One Price (LOOP)If a diamond of high quality sells for 1000 in Amsterdam $4000 in New York The exchange rate is $ Then trader could buy the diamond for $1500 in Amsterdam and sell it for $4000 in New York. Traders would continue doing this, driving up the Price in Amsterdam, and driving down the Price in New York until the Price is (for example) 2000 in Amsterdam and $3000 in New of One Price (LOOP)The Big Mac Index is a (partly tongue in cheek) applications of LOOP.
Law of One Price (LOOP) The Big Mac Index is a (partly tongue in cheek) applications of LOOP. The Big Mac Index has been published for over 20 years by the Economist as an indicator of short term under or over valuations of currencies. Link to July/09 Big Mac Index
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