The Law of One Price in International Trade: A Critical Review

The law of one price (LOP) is one of the most frequently tested economic laws. Although called a law, it has probably been violated more than any other economic law (on the basis of the results of numerous empirical studies). Furthermore, the LOP is often utilized as the building block in international agricultural trade models without previously checking the validity of that assumption for that particular commodity. This can sometimes lead to erroneous conclusions that can have serious consequences on policy-making decisions. This article represents a critical review of recent works that discuss how some factors, such as transportation (transaction) costs, tariffs, nontariff barriers, pricing to market, exchange rate risk, and trade regionalization, can prevent market arbitrage to force closer convergence of international prices. The validity of some methods often used for testing the LOP, such as cointegration analysis, is critically reviewed as well.