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Why does the law of one price not always hold?

GlobalPublished 6 October 2026 · Written by BuyMeWhiskey Editorial Team · How we check facts

The law of one price is an economic tendency, not a guarantee. Identical goods can trade at different prices because transport, taxes, regulation, information gaps, market segmentation, timing and transaction costs can prevent arbitrage.

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When analysing a price difference, list the transaction costs and market frictions before assuming an arbitrage opportunity exists.

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What the law of one price actually says

The law of one price says that, under sufficiently competitive conditions and without barriers to trade, identical goods should tend toward the same price when expressed in the same currency. It is closely related to arbitrage: if one market is much cheaper than another, traders have an incentive to buy in the cheap market and sell in the expensive one.

But the law contains strong assumptions. In the real world, arbitrage is rarely frictionless.

There does not need to be a government enforcer

The “enforcement” comes from market incentives. If a trader can reliably buy an identical asset for less in one place, move it, and sell it for more elsewhere after all costs, other traders are likely to notice the opportunity. Their activity pushes the cheap price up and the expensive price down.

If the gap is smaller than the costs or risks of doing the trade, there may be no profitable arbitrage. That can allow price differences to persist without contradicting the economic idea.

Why does quantity supplied often rise with price?

In a standard supply model, a higher market price can make it worthwhile for firms to produce more units, bring higher-cost production capacity online, or use more resources. The exact supply response varies by industry and time horizon, so “upward sloping” is a model tendency rather than a physical law.

Why can demand rise while price falls?

Demand increasing normally puts upward pressure on price, all else equal. But the market price is an equilibrium outcome determined by both demand and supply. If supply shifts outward by more than demand shifts outward, the equilibrium quantity can increase while the equilibrium price falls.

This is why “demand went up” does not, on its own, prove that the market price must rise. You need to know what happened on the supply side at the same time.

What is the Baumol effect?

The Baumol cost disease describes a situation in which some services have difficulty achieving the same productivity growth as sectors that can automate or scale rapidly. If workers' wages rise broadly across the economy while productivity in a labour-intensive service changes little, the service can become relatively more expensive.

Equilibrium price versus the price observed

In a simple supply-and-demand diagram, equilibrium is where the quantities supplied and demanded are equal. A real market can take time to adjust because contracts, inventories, regulation, capacity constraints and information prevent an instant move to the textbook point.

Common reasons prices differ

Shipping and storage costs.
Taxes, duties and subsidies.
Different regulations or quality standards.
Different currencies and exchange-rate risk.
Limited access to one market.
Information or search costs.
Temporary shortages or excess inventories.

How to test a claimed arbitrage opportunity

Start with the purchase price and the realistic sale price. Then subtract brokerage or transaction fees, taxes, financing costs, transport, storage, insurance and the value of your time and risk. If the apparent profit disappears, the price difference is not a free lunch.

Arbitrage has costs, limits and delays

The law of one price is an economic benchmark rather than a promise that identical goods will have identical prices at every moment. In a frictionless market, a cheaper identical asset creates an arbitrage opportunity: buy the cheap version and sell the expensive one. Real markets add costs and constraints between those two actions.

Transport, taxes, exchange-rate conversion, bid-ask spreads and platform fees can absorb a price gap. Even when the net difference looks profitable, a trader may lack the inventory, borrowing capacity or market access needed to complete both legs. Timing matters too: two prices may refer to different delivery dates, settlement arrangements or quality.

The same reasoning explains why a no-enforcement hypothetical is not enough to make the principle disappear. A price gap can remain precisely because the cost of exploiting it is greater than the gap. Competitive pressure still tends to reduce unusually large differences, but the adjustment is imperfect rather than instantaneous.

Worked example

Illustrative example: The same standardised commodity appears to cost $100 in Market A and $108 in Market B. A trader thinks there is an $8 arbitrage opportunity.

Purchase in A = $100.
Transport and handling = $3 (illustrative).
Transaction and selling costs = $2 (illustrative).
Total landed cost = $100 + $3 + $2 = $105.
Sale price in B = $108.
Illustrative gross trading margin = $108 − $105 = $3.

If the trader also faces financing costs, tax differences, delay risk or a changing market price, that $3 may disappear. The law of one price therefore does not require the quoted prices to be identical every second. It predicts pressure toward convergence when arbitrage is genuinely profitable and feasible.

The figures are illustrative, not a promise of an available arbitrage trade.

How can the law of one price hold without enforcement?#

It is enforced by incentives rather than a central authority. If a price gap creates reliable profit after costs, traders can buy in the cheaper market and sell in the dearer one. Their trades push the prices toward each other until the opportunity becomes too small or risky.

Why does quantity supplied usually increase when price rises?#

Higher prices can make additional production profitable, so firms may use more capacity or bring higher-cost resources into production. The relationship depends on the industry and time horizon, so a supply curve is a model of behaviour rather than a universal mechanical rule.

Can demand increase while price falls?#

Yes. Price is determined by the interaction of demand and supply. If demand shifts outward but supply expands even more strongly, equilibrium quantity can rise while equilibrium price falls. Looking at demand alone is therefore not enough to predict the price movement.

Is the Baumol effect a supply-side or demand-side phenomenon?#

It is mainly discussed as a supply-side productivity problem, although economy-wide wage pressure and consumer demand can affect the observed price. The core idea is that labour-intensive services may experience slower productivity growth than sectors where output can be automated.

Why can the equilibrium price rise when demand rises?#

When demand shifts outward with supply unchanged, the new equilibrium generally has both a higher price and higher quantity. The price rises because buyers are competing for the available supply. A simultaneous supply shift can change that result. For the arbitrage price gap, rely on the governing rule and the current product or scheme terms rather than a generic summary.

Is every price difference an arbitrage opportunity?#

No. A price gap may reflect transport, taxes, market access, information costs, settlement risk, financing or different product quality. Arbitrage exists only when the total cost of executing the trade still leaves a sufficiently reliable profit. For the arbitrage price gap, rely on the governing rule and the current product or scheme terms rather than a generic summary.

Why do identical products cost different amounts in different countries?#

Different tax systems, transport costs, currencies, distribution agreements, regulation and market competition can all create different local prices. The law of one price is strongest for assets that are easy to trade across borders and weakest where goods or markets are segmented.

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Sources

Figures were checked against these sources before publication. If a rule changes, we update the page and show the new date.

General information, not personal financial advice. Rules depend on your circumstances; check the official source or speak to a regulated adviser before acting.