The Law of One Price states that identical goods should have the same price globally. It encompasses characteristics like uniform quality, absence of arbitrage opportunities, and market efficiency. It explains price alignment through market integration and arbitrage. The law applies to commodities, financial assets, and forex trading, with violations stemming from transportation costs and trade barriers.
Economic Principle: The Law of One Price is a fundamental economic principle that asserts that identical goods should have the same price in various markets.
Characteristics:
Identical Goods: The law applies to goods with uniform quality, attributes, and characteristics across different markets.
No Price Arbitrage: The absence of opportunities for risk-free profit due to price disparities prevents arbitrage.
Market Integration: The concept is explained by the alignment of prices through market integration, where interconnected markets influence each other’s prices.
Arbitrage: The possibility of arbitrage, exploiting price differences between markets, further clarifies the law’s principles.
Applications:
Commodity Markets: The law is evident in global commodity markets, where identical commodities like oil and precious metals exhibit convergence in prices due to market integration.
Financial Assets: Financial instruments such as currency exchange rates and interest rates align across markets in accordance with the law.
Violations:
Transportation Costs: Transportation expenses impact price disparities, as they add to the cost and affect the uniformity of prices across markets.
Trade Barriers: Tariffs, regulations, and trade barriers can lead to deviations from the law, causing variations in prices between markets.
Use Cases:
Commodity Prices: Integrated markets lead to commodity price convergence. For instance, oil prices tend to align globally due to market integration.
Forex Trading: In foreign exchange trading, efficient forex markets ensure that exchange rates align according to the Law of One Price.
Examples:
Big Mac Index: The “Big Mac Index” is a lighthearted illustration of the law, using McDonald’s Big Mac as a benchmark to compare purchasing power parity between countries.
Arbitrage Opportunities: Instances of price differences between markets present opportunities for arbitrage, reinforcing the law’s principles.
The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
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The Triple Bottom Line (TBL) is a theory that seeks to gauge the level of corporate social responsibility in business. Instead of a single bottom line associated with profit, the TBL theory argues that there should be two more: people, and the planet. By balancing people, planet, and profit, it’s possible to build a more sustainable business model and a circular firm.
Behavioral finance or economics focuses on understanding how individuals make decisions and how those decisions are affected by psychological factors, such as biases, and how those can affect the collective. Behavioral finance is an expansion of classic finance and economics that assumed that people always rational choices based on optimizing their outcome, void of context.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
