Why Doesn’t Arbitrage Eliminate the Price Difference?

Answer the following questions to check your understanding of the story.

Is Jen Caramichael comparing the prices of identical products?

a) No

b) Yes

Wrong! - Although the Seiko watches are identical, buying them in Tokyo and New York involves different retail services.

That's Right! - The Seiko watch is identical, but the retail services included in the purchase differ between Tokyo and New York.

What is arbitrage?

Buying _____ in one market, and selling _____ in another market.

a) high; high

b) high; low

c) low; low

d) low; high

Wrong! - Arbitrage is done to earn a profit. Buying high and selling low results in a loss. Buying high and selling high, or buying low and selling low is not how arbitrage works.

Well Done! - Arbitrage means buying a good at a low price in one market and selling it at a high price in another market.

What is the outcome of arbitrage?

Arbitrage causes the prices of identical tradable goods in different markets to become ___________.

a) equal

b) higher in both markets

c) permanently different

d) lower in both markets

Wrong! - Arbitrage does not make both prices rise or fall. Arbitrage reduces price differences rather than maintaining them.

Good Job! - Buying in the low-price market and selling in the high-price market raises the low price and lowers the high price until the prices become equal.

Why doesn’t arbitrage result in this outcome in retail markets for watches?

Arbitrage does not eliminate the price difference because the Seiko watches ______________.

a) cannot be transported, and neither can the retail services

b) can be transported, but new retail services must also be provided in New York

c) can be transported together with the retail services provided in Tokyo

d) cannot be transported to New York

Wrong! - Seiko watches are tradable goods and can be transported. Retail services are non-tradable and cannot be arbitraged.

Correct! - The watches can be transported, but the retail services included in the Tokyo price cannot. New retail services must be provided in New York.

Why doesn't Jen Caramichael exploit the price difference by buying Seiko watches in Tokyo for $740 each and selling them in New York for $1,000 each?

Goods with ____________ cannot be fully arbitraged because the cost of transporting them and providing them in the destination market might ___________.

a) only tradable components; be zero

b) only tradable components; use up the entire price difference

c) with a non-tradable component; be zero

d) a non-tradable component; use up the entire price difference

Wrong! - Goods with only tradable components can be fully arbitraged because they can be transported between markets. If the cost were zero, arbitrage could eliminate the price difference.

You Got It! - Goods with a non-tradable component, like retail services, cannot be fully arbitraged because the non-tradable component must be provided in the other market, and its cost might use up the entire price difference.

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