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Chapter 16: Problem 3

Economist Richard Thaler of the University of Chicago noted that most economists consider arbitrage to be one way "that markets can do their magic." Briefly explain the role arbitrage can play in helping markets work.

Short Answer

Expert verified
Arbitrage helps markets work efficiently by maintaining price consistency across different markets. It enables the exploitation of price discrepancies across different markets, which results in prices being homogenised, thereby ensuring fair markets.

Step by step solution

01

Understanding the concept of arbitrage

Arbitrage can be defined as the simultaneous purchase and sale of the same asset on different markets to take advantage of a price difference. Investors use arbitrage as a strategy to make a profit from these price discrepancies without taking on any risk.
02

Elucidating on how arbitrage facilitates markets

Arbitragers act as intermediaries by buying assets at a lower price in one market and selling them at a higher price in another. Through this process, they aid in keeping the prices of assets consistent across different markets. This helps to maintain fair and efficient markets, as there's less probability for skewing of prices induced by anomalies/off-balances in supply-demand dynamics within individual markets.

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Most popular questions from this chapter

In early \(2017,\) a headline in the Wall Street Journal read: "Pricey Virtual- Reality Headsets Slow to Catch On." Is it possible that Sony, Facebook, and the other firms producing virtual-reality headsets were better off keeping prices high when initially offering them for sale, even if the result was a smaller quantity sold? Briefly explain.

Lexmark charges lower prices for its printer cartridges in some foreign countries than it charges in the United States. An article in the Wall Street Journal explained how a company in West Virginia bought Lexmark printer cartridges from retailers in foreign countries and resold the cartridges for higher prices in the United States. a. What must Lexmark be assuming about the price elasticity of demand for printer cartridges in the United States relative to the price elasticity of demand for printer cartridges in these foreign countries? b. Is Lexmark likely to be able to continue to price discriminating in this way? Briefly explain.

Many supermarkets provide regular shoppers with "loyalty cards." By swiping the card when checking out, a shopper receives reduced prices on a few goods, and the supermarket compiles information on all the shoppers' purchases. Some supermarkets have switched from giving the same price reductions to all shoppers to giving shoppers differing price reductions depending on their shopping history. A manager at one supermarket that uses this approach said, "It comes down to understanding elasticity at a household level." a. Is the use of loyalty cards that provide the same price discounts for every shopper who uses them a form of price discrimination? Briefly explain. b. Why would making price discounts depend on a shopper's buying history involve "understanding elasticity at a household level"? What information from a shopper's buying history would be relevant in predicting the shopper's response to a price discount?

(Related to Solved Problem 16.1 on page 541) In 2016 , Walmart closed 150 stores in the United States and deeply discounted the merchandise in them. Some people bought the merchandise at these low prices and resold it on Amazon, eBay, and other sites. An article in the Wall Street Journal described one reseller who "sent three employees in a 26 -foot truck to the nearest closing Walmart, about 160 miles south. ... They hauled off \(\$ 35,000\) in merchandise, like Legos and Star Wars pajamas, which he said he expects to sell for as much as \(\$ 100,000\) on Amazon." a. Is the reseller making a \(\$ 65,000\) profit on these goods? Briefly explain. b. Is the reseller exploiting the people who buy these goods from him on Amazon? Briefly explain.

While in Shanghai, China, to teach an MBA course, Craig Richardson, an economics professor from WinstonSalem State University, asked his American students to haggle with sellers in a market where prices for the same items can vary widely. Professor Richardson explained that the same item with the same sticker price at different market stalls can have a final price that varies "by \(1,500 \%\) or more, depending on the negotiating skills of the buyer." a. Do Shanghai merchants practice price discrimination? Briefly explain. b. Which consumers are likely to pay the highest prices for similar items in the Shanghai market?
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