Arbitrage

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The dismal science
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Arbitrage is business practice by which differences in prices for the same good are taken advantage of by some seller. A good will be purchased in a market where it is cheap, then resold in one where it is higher, the difference will yield a profit. To put it simply, buy low, sell high.[1]

The basics[edit]

Arbitrage is done when discrepancies in real prices for the same good offer real chances to make profits. This can be done both domestically and internationally.[2] Suppose a gallon of milk costs $1.00 in the United States but $3.00 in Canada. The intelligent capitalist sees this, buys up a lot of milk in the USA and sells it in Canada for a handsome profit. Because of the ever fluctuating nature and uncertainty of exchange rates, transportation costs, tariffs, and taxes in the real world this process is often a bit messier, with far less even numbers.

High vs. low risk[edit]

Low risk arbitrage is usually about selling in markets where the price is already well established and the future is fairly certain. Investors, will sometimes gamble, buying an item they believe will still be expensive later, or perhaps go up more in price. If the price does stay high, they win, if it goes down quickly, they lose.

Supply and demand, to the rescue[edit]

See the main articles on this topic: Supply curve and Demand curve

Over time as more sellers try to capitalize on the profit-making opportunity the high price market will become flooded with more of the product. Absent big increases in demand, the increases in total supply will drive down prices as sellers now have more and more competition. In our previous milk example, as time would pass more capitalists would start buying milk in the USA (driving up the price there) and sell it Canada (lowering the price there). In theory the prices would equalize over time. This assumes of course, continuous availability of supply. Sometimes the item in question is inherently rare and non-fungible,Wikipedia in which case there is little or no equalization of the two curves. Examples include: exceptionally large gems (e.g., the Hope Diamond), rare fossils in private hands (e.g., T. rex), very rare books (e.g., Gutenberg Bibles), and famous artwork (e.g., the Mona Lisa).

See Also[edit]

References[edit]

  1. Arbitrage basics. Khan Academy
  2. Chen, James & Gordon Scott. "Arbitrage". Investopedia. Retrieved 2020-02-04.