The Law of One Price in Scandinavian Duty-Free Stores

Abstract

Many empirical studies have rejected the law of one price. That prices of a good differ across locations has been explained by differences in product attributes and costs of local inputs, transport costs, trade barriers, and that buyers have imperfect information about prices in different locations; see Penelopi K. Goldberg and Michael M. Knetter (1997) for a survey. We examine the law of one price in situations where none of the mentioned reasons for its failure can be invoked. It has also been suggested that deviations from the law of one price are a consequence of rigid nominal prices and that different countries typically have different currencies. We explore if this can contribute to our understanding of deviations from the law of one price. Our data is taken from three Scandinavian duty-free outlets where each product (at the same location) has price tags in at least two currencies. Hence, a consumer has the option to choose between several prices for the same identical good. In such a setting there is a strong prior that the law of one price (LOP henceforward) holds well. However, the potential for arbitrage will arise since nominal prices are not continuously adjusted while exchange rates fluctuate daily. Based on standard tests, we reject LOP at all duty-free outlets. Given that LOP does not hold here, it is less surprising that many previous studies have found that prices of similar products at different locations differ significantly. Nevertheless, the main conclusion of the paper is that in this "natural experiment", LOP remains a useful guide to the behavior of relative prices. As deviations become large, nominal prices are adjusted to reduce the deviation from LOP, thereby limiting arbitrage opportunities. The patterns at the duty-free outlets suggest that there is a band of inaction so that "small" deviations from LOP may persist (for almost a decade in one case), but that large deviations quickly lead firms to adjust relative prices. The findings are consistent with costly arbitrage and fixed costs of adjusting nominal prices.

International Prices, Costs, and Markup Differences

“…Crucini and Shintani (2008) and Crucini et al (2005) for instance, examine the retail price of narrowly defined product categories, such as "Washing Powder, "across countries within the European Union. Others focused on specific goods, such as The Economist magazine (Ghosh and Wolf 1994), Ikea's furniture products (Haskel and Wolf 2001;Hassink and Schettkat 2001), or Scandinavian McDonald's duty-free outlets (Asplund and Friberg 2001).…”

Market Integration and Convergence to the Law of One Price: Evidence from the European Car Market

“…Engel and Rogers (1996) report that the border between the U.S. and Canada is ''2500 miles wide'', meaning that crossing the border adds as much to the volatility of prices as adding 2500 miles between cities, while Parsley and Wei (2001) estimate the U.S.-Japan ''border'' to be 43,000 trillion miles wide. In a recent study, Asplund and Friberg (2001) find that the LOOP does not even hold for identical goods sold at the same location, as long as these goods are dominated in different currencies (the evidence comes from price data of products sold in Scandinavian duty-free stores). While various explanation have been suggested in the literature-with normal exchange rate volatility being the primary contender-there is little agreement as to what factors generate international price dispersion in the first place, and what mechanisms can accelerate convergence to the LOOP.…”

Do Gasoline Prices Converge in a Unified Europe with Non-Harmonized Tax Rates?

“…Only recently, some panel studies for selected products seem to support the convergence hypothesis, although convergence takes place at a very slow speed (see Goldberg and Verboven, 2001, for references). As results by Asplund and Friberg (2001) show, the LOOP may not even hold for identical products at the same location, if denominated differently.…”