What Is the Law of One Price?

the price
The law of one price is an economic concept that states that
of an identical asset or commodity will have the
same price globally, regardless of location,
when certain factors are considered.
The law of one price takes into account a frictionless market, where there are
no transaction costs, transportation costs, or legal restrictions, the
currency exchange rates are the same, and that there is no price
manipulation by buyers or sellers. The law of one price exists because
differences between asset prices in different locations would eventually be
eliminated due to the arbitrage opportunity.

What Is Purchasing Power?

Purchasing power is the value of a currency expressed in terms of the
number of goods or services that one unit of money can buy. It can weaken
over time due to inflation. That's because rising prices effectively
decrease the number of goods or services you can buy.
Purchasing power is also known as a currency's buying power.

Example : The number of goods we can buy with the amount of

1,000 10 years ago is lesser now.
If we can buy 5 kilos of rice in 1OO pesos before we can buy 2
kilos of rice with our 100 pesos now.

Absolute and Relative Parity

1. Absolute parity
Absolute purchasing power parity (APPP) is the basic PPP theory,
which states that once two currencies have been exchanged, a basket
of goods should have the same value. Usually, the theory is based on
converting other world currencies into the US dollar.

For example, if the price of a can of Coca Cola was $1.50, APPP
would suggest that a can of Coca Cola in any other country should
cost $1.50 after you’ve converted USD into the local currency.

If this does not hold true, then APPP suggests that the currency
exchange rate will change over time until the goods are of equal value
– as without any barriers to trade, there should be an equilibrium in
the price of goods. This is a completely price-level theory, which only
looks at the exact same basket of goods in each country, with no other
factors included.

2. Relative parity
Relative purchasing power parity (RPPP) is an extension of APPP and
can be used in tandem with the first concept. While it maintains that
the value of the same good in different countries should equal out over
time, RPPP suggests that there is a correlation between price inflation
and currency exchange rates. It looks at the amount of a good or
service that one unit of currency can buy, which can change over time
as inflation rates alter. The theory suggests that inflation will reduce
the real purchasing power of a currency, so in order to properly adjust
the PPP, inflation must be taken into account.