When focusing on the trade happening between countries, there is isolation effect to the prices of each participating country. This allows for the extraction of the pure influences of the prices. With a two-country model which had rigid transportation cost, the changes in the law of one price (LOP) are lower for the products with less recurrent price modification after controlling from the distance separating the two countries (Crucini, Shintani, and Tsuruga 5).
The law of one-price state: identical goods have similar prices regardless of the products position on the Globe market. The law makes use of the theory of purchasing power parity and arbitrage postulations.
This economic law must hold true in a perfectly competitive market without charges being accounted on transportation and barriers. In the real practice, the details of available market restrictions is necessary in determining the laws abuse (Lamont & Thaler 1).
The supply and demand influences the arbitrage. All the sellers are motivated to sell their good in the market fetching them higher profits. This leads to lowering of the product supply in the areas of low prices and increasing of the supply in the regions with high prices. In case the demand remains constant, the elevated product supply will lower the prices in the high priced areas and lower supply in the lower priced areas. Hence, pushes the product prices up (Lamont & Thaler 2).
Alternatively, the consumers relocate to the areas with low priced product to purchase the product at reduced costs and the product demand is elevated and in the area. However, in the high priced areas the prices will pull downwards as the consumers migrates the regions (Lamont & Thaler 2).
After a long time, the two places will end up having similar price.
According to the case study, there are two market settings. The USA market has high prices of oil and oil products but outside the USA is having low prices.
If the crude oil products were charged tax in the USA while the crude oil remained untaxed, the crude oil producers outside the USA will benefit as the Crude oil producers in the USA suffers. Moreover, outside the USA market will acquire a higher number of crude oil producers as those in the USA migrate. The failure to tax crude oil supplied in the USA create a higher supply of the crude oil to the USA as outside the USA has lower price than the USA.
If the condition is kept constant for long, the higher supply of the crude oil in the USA will lower the Demand of the crude oil in the USA and this lowers its price. Outside the USA, prices are lower than the USA. Hence, the supply lowers and the demand increase, which increases the prices outside the USA.
Alternatively, the consumers of the crude oil relocate outside the USA to exploit the cheap sources of the crude oil. This raises the demand of the crude oil and the prices increases. However, the demands in the USA decrease as consumers migrate leading to the lowering of the prices.
In the end, the price of crude oil outside the USA and in the USA becomes equivalent.
On levying tariffs to imported crude oil and avoiding imposing tax on the crude oil products, the producers of crude oil products outside the USA benefits while the producers of the crude oil products within USA suffers. Besides, some crude oil products consumers migrate to outside the USA.
After a long time, the number of crude oil products suppliers to the USA increases as the number of the supplier of the crude oil products to other regions outside the USA market reduces. This lowers the supply of the crude oil products outside the USA and increases the supply in the USA.
Alternatively, consumers relocate from the USA to outside the USA to enjoy lower prices of crude oil products. The demand of the oil products outside the USA increases while in the USA reduces due to lowering of the supply, as buyers will have relocated massively.
Eventually, the prices of the crude oil products get to one figure.
The economic consequence of charging tax on both crude oil and the crude oil products includes reduced imports of the crude oil and crude oil products. Outside the USA commands a lower price of the crude oil and crude oil products. Hence, the USA crude oil producers and the crude oil product producers will be limited to the USA market only.
Moreover, the USA consumers enjoy the unchanged prices and their rates of consumption will remain constant. Besides, the companies exporting crude oil and crude oil products stands a poor chance against outside the USA competing crude oil and crude oil products producers who sell their products cheaply than the USA crude oil and the crude oil product producers.
As the price of the crude oil and crude oil products outside the USA increases in response to tax increase, the suppliers outside the USA supplies lower amount of crude oil and crude oil products after the tax is raised. This lowers the demand, supply and price of the crude oil and crude oil products outside the USA.
The expected oil difference between the heating oil and gasoline prices in the New York and Rotterdam after the 1970s price control of the crude oil through taxing crude oil only included the following.
In the New York, the supply of the crude oil products was higher while the supply of the crude oil products in Rotterdam was lower as New York had a higher price than Rotterdam. This led to increased demand of crude oil products in the New York while the demand in the Rotterdam decreased.
Alternatively, oil producers in the New York relocated to Rotterdam. This increased the supply of crude oil products in Rotterdam and lowered the supply in the New York. As a result, the demand of the crude oil products in New York increased as the Rotterdams reduced. This led to decreased prices of the oil products in the New York as the prices in Rotterdam decreased.
From the above, the following is noted. Restriction influences the law of one price. Moreover, the violation of the law of one price occurs there is a difference among identical commodities, and impediment happens to avoid the arbitrageurs from reinstating the prices fairness predicted by rationality (Lamont and Thaler 1).
The figure above assumes the prices of wheat in Chicago and Liverpool are similar and the law of one price governs the prices equilibrium. Suppose the price of wheat in Chicago is affected by the local shocks to make the price of wheat in Chicago rise higher than that in Liverpool.
If this occurs in Chicago at time t-1, the prices in Liverpool will rise at time t as the prices in the Chicago lowers at the same time. This is influenced by the rise of supply in Liverpool as traders tries to make more profit and lowering the demand in the Liverpool. However, the supply in Chicago lowers and pushes demand upwards.
Crucini M. J., Shintani M., and Tsuruga T. “The law of one price without borders: the role of distance versus the sticky prices.” Economic Journal Royal Economic Society. 120.544 (2010): 462-480. Print.
Lamont O. A. and Thaler R. H. “The law of one price in financial market.” Journal of Economic Perspectives. 17.4 (2003): 191-202. Web.