Answer to Question 1:

The law of one price

1. always holds because every good has the same price throughout the entire market.

2. implies that the domestic and foreign price levels will be the same when prices are measured in the same currency.

3. says that any given good will have the same price in every country when the prices are measured in any given currency.

4. holds when prices are considered net of transport costs, tariffs, taxes, subsidies and other impediments, but only for goods that are internationally traded.

Choose the correct option.

The correct choice is option 4. The law of one price was defined as a situation where the equation

             Px   =   Π P*x 

holds for good  x  in the economy. This requires that the good be internationally traded and that prices be measured net of taxes, tariffs, subsidies and all other impediments. The prices of goods that are not internationally traded can be uniform in each country's home market but different in the different countries. Since prices of non-internationally traded goods differ from country to country, the countries' price levels cannot in any sense be the same.

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