What is the difference between the “Law of one price” and “Purchasing Power Parity?
The law of one price states that differing prices of a traded good will tend to equalize in the absence of tariffs, other barriers to trade and prohibitively high shipping rates. The law of one price can also be stated as: “In an efficient market all identical goods must have only one price.” The purchasing power parity (PPP) theory is based on the law of one price and uses the long-term equilibrium exchange rate of two currencies to equalize their purchasing power. In other words, the PPP hypothesis is that free trade of goods will align exchange rates with their PPP values.
