In this ongoing sale season, we found a stellar pair of discounted shoes at the Nike showroom in Pacific Mall, West Delhi. Our friend, having skipped this shopping session, was now motivated to bag a similar steal near her place in South Delhi. To her dismay, no Nike store in malls there had any discounts.
Exchanging our experiences, we asked ourselves, if the same product was available for two distinct prices in Delhi, then why weren’t traders exploiting this arbitrage opportunity, i.e., buying the Nike shoes for cheap at Pacific Mall and selling them at a higher price (but cheaper than the mall price) at any South Delhi Mall? Economic theory predicts that over time, more such traders should emerge, which should eliminate the profits from arbitrage and result in equal prices across 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 piece, we explore and explain why the LOOP doesn’t apply here, given the chance for arbitrage.
Economists term this pricing pattern as spatial price dispersion (SPD) where an identical product (Nike shoes) are offered at different prices across several stores contemporaneously (two locations in Delhi). Two noted economists Salop and Stiglitz discuss that SPD exists because of the presence of two kinds of consumers: “informed” and “uninformed” consumers (ones who do and do not know about the distribution and trends of offered prices, respectively). Therefore, the “informed” customer (think price-conscious bargain hunters) always goes to the low-priced store, while the “uninformed” customer (think spendthrift brand enthusiasts) prefers shopping at more convenient locations.
In our context, the SPD for Nike shoes across the two locations exists because the affluent South Delhi residents may be less “informed” than the cost-effective shoppers of Pacific Mall. For example, an advertisement that says “fill your details to avail a special discount at Pacific Mall”, is more likely to lead to higher demand for the discounted products among the “informed” consumers while going completely unnoticed among nonchalant high-end shoppers. Over time, the stores learn that “uninformed” or affluent shoppers are less willing to expend extra efforts to be perfectly informed and realize the willingness of the “uninformed” consumers to pay a higher price. This distinct nature of the sets of consumers allows the stores to charge differential retail prices.
If SPD can explain the existence of differential retail prices, then why aren’t any traders exploiting the opportunity to arbitrage Nike shoes across the stores of Delhi? This is because the existence of SPD requires an important precondition- the brand must have reputation and influence in its market. Nike’s strong brand value undermines any arbitrage opportunity. For instance, suppose there were to be a vendor, who buys shoes from the Pacific Mall and sets up a stall outside the South Delhi mall to sell them. Since the vendor is not recognized as a Nike Franchise, he/she will not be able to reliably authenticate the product. A more observant reader can argue that the vendor may produce a receipt of purchase but its authenticity will still be questionable, especially in the presence of a large counterfeit market. Any consumer will be wary of a vendor who is claiming to sell the Nike shoes at price cheaper than the store inside the mall. Hence, this pre-condition hampers the arbitrage opportunity and undoes the LOOP.
Reading this, the residents of South Delhi might become inclined to shop around for the lowest prices outside their locality. But alas! If only it was that simple. This would incur a hefty “search cost”. Maybe the residents should fall back on their preferred and most popular shopping destination - Sarojini Nagar (SN) a counterfeit, factory reject market. At SN, buyers can experience a regret-free shopping spree with prices lower than any mall, all while allowing our dear shoppers to boast about their bargaining skills.
(Payal Seth is a consultant at the Tata-Cornell Institute, Cornell University, USA. Abhishek Ananth is a post-doctoral fellow at the University of Geneva, Switzerland. Views expressed in this article are personal and may not necessarily reflect the views of Outlook Magazine).