During this current sale season, we found a great pair of discounted shoes in the Nike showroom in Pacific Mall in West Delhi. Our friend, after skipping that shopping spree, was now motivated to take a similar flight near her home in South Delhi. Much to her dismay, no Nike store in malls offered discounts.
In exchanging our experiences, we wondered if the same product was available at two separate prices in Delhi, so why didn’t the traders exploit this arbitrage opportunity i.e. buy the Nike shoes at low price at Pacific Mall and sell them for a higher price (but cheaper than the mall price) in any mall in South Delhi? Economic theory predicts that over time more such traders should emerge, which should eliminate arbitrage profits and result in equal prices in all locations for the same product. This is called the Law of One Price (LOOP) which states that under the assumption of frictionless markets and equal production costs, the price of an identical good will be the same across the world. In this article, we explore and explain why LOOP does not apply here, given the possibility of arbitration.
Economists call this price model spatial price dispersion (SPD) where an identical product (Nike shoes) is offered at different prices in several stores simultaneously (two locations in Delhi). Two well-known economists, Salop and Stiglitz, explain that the SPD exists because of the presence of two types of consumers: “informed âandâ uninformed âconsumers (those who know and do not know the distribution and trends of the prices offered, respectively). Therefore, the “informed” customer (think of price-conscious bargain hunters) always goes to the store at a low price, while the “uninformed” customer (think of spendthrift brands) prefers to shop in the store. more convenient places.
In our context, the SPD for Nike shoes at both sites exists because affluent South Delhi residents may be less âinformedâ than profitable Pacific Mall shoppers. For example, an advertisement that says “fill in your details for a special discount at the Pacific Mall” is more likely to result in higher demand for the discounted products among “informed” consumers while going completely unnoticed. among leisurely high-end buyers. Over time, stores learn that âuninformedâ or affluent shoppers are less willing to go the extra mile to be fully informed and realize the willingness of âuninformedâ consumers to pay a higher price. This distinct nature of consumer sets allows stores to charge differential retail prices.
If SPD can explain the existence of differential retail prices, then why is no merchant exploiting the opportunity to arbitrate Nike shoes in Delhi stores? Indeed, the existence of the SPD requires an important precondition: the brand must have a reputation and influence in its market. The strong value of the Nike brand undermines any arbitrage opportunity. For example, suppose there is a salesperson who buys shoes from the Pacific Mall and sets up a stall outside the South Delhi Mall to sell them. Since the seller is not recognized as a Nike franchise, they will not be able to reliably authenticate the product. A more attentive reader may argue that the seller can produce a purchase receipt but its authenticity will always be questionable, especially in the presence of a large counterfeit market. Any consumer will be wary of a salesperson who claims to sell Nike shoes for a lower price than the store inside the mall. Therefore, this precondition hinders the opportunity for arbitration and cancels the LOOP.
Reading this, people in South Delhi might be inclined to seek the lowest prices outside of their locality. But unfortunately! If only it was that easy. This would result in a heavy “research costs â. Perhaps residents should fall back on their favorite and most popular shopping destination – Sarojini Nagar (SN), a counterfeit and factory reject market. At SN, shoppers can experience a no-regret shopping spree with prices lower than any mall, while still allowing our dear shoppers to brag about their bargaining skills.
(Payal Seth is a consultant at the Tata-Cornell Institute, Cornell University, USA. Abhishek Ananth is a post-doctoral researcher at the University of Geneva, Switzerland. The opinions expressed in this article are personal and do not necessarily reflect those of Outlook. Magazine).
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