Arbitrage and Geographic Price Patterns

The simplest case is one in which speculative activity reduces or eliminates regional price differences’ by buying and selling the same commodity. This’ activity is called arbitrage, which is the purchase of a good or asset in one market for immediate resale in another market in order to profit from a price discrepancy.

Let’s say that the- price of wheat is 50 cents per bushel’ higher in’ Chicago than in Kansas City. Further, suppose that the costs of insurance and transportation are 10 cents per bushel. Then an arbitrager (someone engaged in arbitrage) can purchase wheat in Kansas City, ship it to Chicago, and make a profit of 40 cents per bushel. As a result of market arbitrage, the differential will be reduced so that the price differential between Chicago and Kansas City can never exceed 10 cents per bushel. Mort generally, as a milt of the markets be less than the cost of moving the good one market to the other.

The frenzied activities of arbitragers-talking on the phone simultaneously to several brokers in several markets, searching out price differentials, trying to eke out a tiny profit every time they can buy low and sell high-c-tend to align the prices of identical products in different markets. Once again, we see the invisible hand at work-the lure of profit acts to smooth out price differentials across markets and make markets function more efficiently.

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